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Schwab’s Kleintop: 5 Surprises to Prepare for in 2015

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Forecasters have made a number of predictions when looking at the 2015 financial landscape — things like slower growth for China, an interest rate hike by the Federal Reserve, a rising dollar and continued low volatility. But what if they’re wrong?

“There is a high degree of confidence among market participants — ourselves included — in several outcomes for 2015,” writes Jeffrey Kleintop, senior vice president and chief global investment strategist at Charles Schwab. “That could lead some investors to take it for granted that they are sure to happen.”

So, what if these assured outcomes don’t happen? What if the unexpected happens? Kleintop examines what could be five possible surprises of the financial landscape in 2015 in a commentary released last week.

“These are not necessarily surprises we expect to happen in 2015, but ones we want to be mindful of given that market participants in general seem unprepared for them and that such situations could prompt a dramatic reaction if they occur,” Kleintop stresses.

Kleintop’s simplest suggestion is to be prepared.

“Whether or not these particular surprises come to pass, a new year almost always brings surprises of one form or another,” he writes. “Having a well-balanced, diversified portfolio and being prepared with a plan in the event of an unexpected outcome are key aspects of successful investing.”

Here are the five surprises he urges investors to be ready for:

China's growth accelerates. (Photo: AP)

1. China’s growth accelerates

Roughly 95% of economists expect slower growth for China in 2015 than in 2014, Kleintop says. He points to figures from Bloomberg LP that show economists have been revising down their growth outlook for China. Right now, the consensus is for 7% growth of China’s gross domestic product in 2015, which is down from a projected 7.2% four months ago and 7.4% for 2014.

So, Kleintop asks, what could cause this outlook to be wrong?

“For one thing,” he says, “Chinese new business startups are soaring thanks to reduced red tape, even amid slower growth for state-owned enterprises.”

Revisions to China’s GDP in December showed a changing composition of GDP growth from export-oriented manufacturing toward the service sector, which has benefited from rapid startup growth.

Kleintop’s surprise outcome: “Better growth could drive better performance for China’s stock market.”

The Fed doesn't raise interest rates

2. The Fed doesn’t raise interest rates

Another thing economists are fairly certain of is the Fed raising interest rates in 2015, at least according to 95% of economists tracked by Bloomberg.

“But it could be a closer call than this high percentage indicates, given the changing membership of the Federal Open Market Committee and the state of the economy,” says Kleintop.

Kleintop breaks down the vote on the Fed’s action in December that was approved 7-3.

“The three dissents from the majority view reflect rising discord inside the Fed over the best course of action,” he says.

Of the FOMC’s members that favor rate hikes, Kleintop points out that two (Philadelphia Fed’s Charles Plosser and Dallas’ Richard Fisher) are retiring and another (Cleveland Fed’s Loretta Mester) will not be a voting member in 2015.

And while the most vocal proponent to keeping rates low (Minneapolis Fed’s Narayana Kocherlakota) will also not vote next year, Kleintop says he will most likely be replaced by a “similarly minded” Charles Evans from the Chicago Fed.

“These changes could affect the timing of interest rate hikes — especially if the U.S. economy experiences a soft spot in the first half of the year, which has become a common occurrence in recent years,” Kleintop says.

Kleintop’s surprise outcome: “If the Fed does not raise interest rates in 2015, shorter-term yields in the United States, such as that of the 2-year Treasury note, could reverse part of their rise over the past six months, producing gains for Treasuries. A failure to raise rates could also result in a weaker dollar, which may benefit international markets, including emerging markets.”

Europe announces aggressive stimulus

3. Europe announces aggressive stimulus

The European Central Bank, which is prone to implementing any actions slowly and often temporarily or limited in size and scope, continues to discuss a range of options for additional economic stimulus, including government bond purchases.

Kleintop says most central bank watchers see a wide gap between discussing such purchases and actually making them, largely because “political constraints, already-low interest rates, and the Eurozone’s bank-centered—rather than capital-market centered—financial system” limit the potential effectiveness of bond purchases.

“Regardless of the size of the purchases, the political cost is the same, so if the ECB decides to take on this cost it may seek to get the most impact by announcing an intention to make aggressive purchases,” Kleintop says, adding that “plans to aggressively take such action could result in a powerful shift in longer-term inflation expectations and the exchange rate.”

Kleintop’s surprise outcome: “European stocks could rise sharply on an announcement of aggressive government bond buying by the ECB.”

The dollar falls

4. The dollar falls

“The dollar’s big climb made headlines in 2014, and participants in the currency futures markets are betting big on a further rise in 2015,” writes Kleintop.

A strong economy and the likelihood of Fed rate hikes helped boost the dollar.

But it was geopolitical events this past year – like the Ukraine conflict and Russian sanctions, the Scottish referendum on dividing the U.K., the rapid invasion of Iraq by ISIS, the  failed Greek presidential elections due to a rising anti-Euro sentiment, and the Ebola threat – that helped make the dollar the top-performing major currency in 2014.

While the dollar has often historically been the beneficiary of these types of global events, the history also shows how these events can also have the opposite effect.

“Over the past 35 years, even during the two extended periods of dollar strength that were supported by differences in growth and interest rates, the dollar occasionally saw sharp drops along the way as other global factors intervened.

Kleintop’s surprise outcome: “A weaker dollar may boost returns for U.S.-based investors’ overseas investments as gains in foreign currencies are translated into more dollars.”

Stock market volatility surges

5. Stock market volatility surges

The CBOE volatility index stayed well below 15 for much of the year, which Kleintop says shows that “market participants were pricing in a continuation of the low volatility environment of recent years.”

When long-term bond yields are much higher than short-term bond yields, short-term interest rates are usually being kept artificially low by the Fed in order to stimulate growth. Kleintop calls this “periods of excess liquidity” because of the increased amount of cheap funding available.

“The correlation between high liquidity and low volatility suggests the Fed may have been a key factor in calming the markets,” Kleintop says. “If the Fed begins to take away the liquidity with rate hikes in 2015, volatility may return. Without the shock absorber of the Fed’s zero interest rate policy, investors may feel any bumps more acutely.”

Kleintop’s surprise outcome: “The return of volatility could result in an unexpectedly wild ride for investors who have not rebalanced their portfolios. It also may benefit those who pursue a dollar-cost-averaging approach to investing.”

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