A panel of four Schwab strategists presented their 2015 outlooks for the markets and economy on Thursday in New York, with the consensus holding that the long-running secular bull market will continue into the new year. In addition, they agreed that the Federal Reserve is likely to raise interest rates next year, with fixed income strategist Kathy Jones saying she expects the Fed to start with short-term interest rates, perhaps as early as the late first quarter or the second quarter.
“We expect the Fed to hike short-term rates” in 2015 producing a “flatter yield curve,” Jones said, since there are still powerful deflation forces at work “around the world,” tempering the Fed’s desire to raise longer-term rates. She also pointed out the “divergence in central bank” policies around the world, especially with the Bank of Japan and the European Central Bank continuing their easing policies compared to the Fed.
She also prompted laughter from the audience of journalists and advisors in the audience when she said “I used to hear people say they were worried about when rates will rise; now they can’t wait for them to rise!”
However, Jones says her team has been closely watching one part of the fixed income market — junk bonds in the energy sector. “We’ve been worried about risk-reward in junk bonds; [falling] oil [prices] has just exacerbated” that worry, noting that 15% of the Barclay High-Yield index is represented by energy companies.
Bond traders are seeing “many offers” to sell, Jones said, but “no bids.” She warned that investing vehicles like mutual funds or ETFs that hold those energy junk bonds might face a liquidity issue, and that “we’ve yet to see the ramifications of companies trying to roll over their debt” in the energy sector when the underlying price of oil has fallen so far.
Schwab’s chief investment strategist, Liz Ann Sonders, made her continued case that we remain in a secular bull market marked by “ferocious returns” for U.S. equities, though she warned “that doesn’t mean we won’t have drama,” soberly reminding the audience that the 1987 crash occurred during the longest-ever secular bull market.
The U.S. economy, Sonders said, will have less fiscal drag holding it down in the new year since the Fed has tapered QE, and the American consumer “will be fine,” partly because of a rise in free cash flow emanating from the decline in commodity prices, especially those lower energy costs.
With consumers still feeling the “muscle memory” of the last two recessions holding them partly in check, she believes we’re coming into an “investment-led expansion” rather than a consumer-driven expansion, though “some volatility” remains possible.
“Oil and gas has been a big part of the investment-led expansion,” she said, pointing out that 8% to 10% of U.S. companies capital expenditures are in the energy sector, accounting for 1% of U.S. GDP and 24% of the S&P 500.
While oil prices have dropped, she said that “break-evens are in the sub-$60 [a barrel] range” for the major Bakken and Eagle Ford shale oil-producing areas of the country.
She also argued that more corrections like the pullback in October would be good for sustaining the bull market. “If I had my druthers, I’d like to see another October,” she said, because it would “elongate the cycle.”
It would also be good, she said in response to a question from an advisor, in showing investors (and advisors’ clients) the benefits of expansion. That advisor had said that in dealing with clients, “it seems like the late ‘90s when we had to defend diversification” with clients prior to the dot-com crash. Sonders said drily that “we didn’t hear those kinds of questions in October.”
International Investing and Derivatives
Jeffrey Kleintop, the former LPL Financial strategist who is now chief global investment strategist for Schwab, sees “better GDP globally” in 2015, helped by the fact that in much of the rest of the world, “austerity is dead.” He cited tax cuts in France and Italy and “broadly stimulative” monetary policy in Europe, Asia and Japan for his optimism, saying that foreign governments have “been in recession for the last five years” when it comes to spending, but “that’s ending.”
Already,“assets are moving into emerging markets,” he said, since “we think pessimism has been priced in.” Moreover, Kleintop said emerging markets do well when “global trade perks up.” As for falling oil prices, Kleintop said emerging markets are no longer mainly about energy consumption and commodity exports.
In Europe, Kleintop sees the “potential for higher profits” from corporations, but serious profit growth will “require structural reform.” As an example, he cited the current parliamentary scuffle over raising the number of Sundays every year in which non-food retail outlets can be open. “Non-food retailers can only be open five Sundays a year; there are fireworks in Parliament over raising that to 12 Sundays a year!”
The final member of the strategist panel, Randy Frederick, managing director or trading and derivatives at Schwab, works with active traders, especially in the options arena. From that perspective, he says that institutions that “tend to use options when they have an opinion” about a coming change in the markets have not been active, signaling that very few expect the markets to go down.
“Anxiety levels about the market are significantly lower” in the derivatives market than they were in the June-October 2014 period, he said, when those institutions expected higher volatility, which happened in October when the VIX spiked to 30 before settling back down to the lower teens.
The only potential “catalyst” Frederick sees in the derivatives markets will be if the Fed raises rates in four to five months.
— Check out Schwab’s Sonders: Bull Market Still in Optimism Phase on ThinkAdvisor.