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Koesterich: Expect More Volatility in 2015

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Last week may be a prelude to what’s to come in the coming year, according to Russ Koesterich, BlackRock’s Global Chief Investment Strategist, and his latest Weekly Investment Commentary.

What happened last week? A recap: Global stocks finished with solid gains, but not without what Koesterich calls “wild gyrations” along the way. In the U.S., the Dow Jones Industrial Average climbed 3.03% to close the week at 17,804, the S&P 500 Index rose 3.40% to 2,070, and the Nasdaq Composite Index was up 2.40% to 4,765. Meanwhile, the yield on the 10-year Treasury inched up from 2.10% to 2.17%, as its price correspondingly fell.

“Expect more episodes of volatility as we enter the new year,” writes Koesterich. “An important driver of that volatility will be markets adjusting to less accommodative U.S. monetary conditions. But on top of that, investors will continue to wrestle with several lingering geopolitical issues, particularly with respect to Russia.”

Lower oil prices, which fell another 6% last week and are now down roughly 45% year-to-date, are a big part of Russia’s problems. According to Koesterich, “plunging oil prices are inflicting real harm on several emerging market countries, notably Venezuela and Russia.”

The Russian market and currency, which had stabilized by Friday, looked rockier earlier in the week when the Russian ruble had plunged despite a massive interest rate hike by the Russian central bank.

(See Mohamed El-Erian’s recent blog on Russia: Emerging-Market Crises Show Way for Russia: El-Erian)

According to Koesterich, this rate hike was the largest single increase since 1998, when Russian rates soared past 100% and the government defaulted on its debt.

It’s this history that makes Koesterich nervous.

“Despite a current account surplus and relatively low levels of debt, the combined effect of lower oil prices and economic sanctions leaves the Russian market vulnerable to speculative pressures,” hewrites. “In short, the worry is that an economic contraction morphs into a financial crisis in the country.”

Koesterich suggested in July that market volatility would likely rise “from the unusually low levels that characterized 2013 and the first half of 2014” as the date of a first Fed rate hike approached.

“Indeed, since the summer, equity market gains have been accompanied by greater gyrations,” according to Koesterich. “Between Jan. 1 and the end of August, the average daily close on the VIX Index (a common measure of stock market volatility) was 13.5. The average has now risen to 15.5.”

Looking forward to 2015, Koesterich’s recommendation is prepare for volatility and focus on assets where value offers some downside protection.

Despite the severe volatility last week, U.S. growth is expected to provide a tailwind for stocks. Last week, stocks were helped by more evidence of U.S. economic strength. Industrial production rose 1.3% last month and is now up 5.2% year-over-year, the fastest pace in almost four years.

Koesterich expects the U.S. economy to enter 2015 with strong momentum, which he says should help company earnings growth and thus allow stocks to move higher next year. 

Meanwhile, outside the U.S., global equity markets, at least in the developed world, managed to finish with solid gains despite volatility. Emerging markets performance last week was more mixed; Chinese equities, though, continued to outperform, up more than 5% last week.

Looking at last week’s performance, Koesterich recommends that investors in 2015 “seek growth potential in select emerging markets, particularly in Asia.” 

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