Friday, January 2, 2015

"Expect the Unexpected," my...

...nephew said someone told him at his new job. And when it comes to the financial markets that's not bad advice, because it always seems that the expected just doesn't come to pass.

Take this piece from the Times yesterday, "Five Surprising Economic Trends in 2014, and What They Mean for 2015." In it Neil Irwin cites five "major moves that defied expert consensus this time a year ago — not only what was predicted, but what was even thought plausible":

1. There was an epic collapse in oil prices.

Crude oil declined about 50 percent in the second half of 2014. Wow.

2. Long-term interest rates kept falling.

The yield on the 10-year Treasury note fell to 2.17 percent on Wednesday from 3.03 percent at the end of 2013, and yields on the 30-year fell below 3 percent from about 4 percent. Almost no one expected this.

3. The U.S. stock market kept cruising.

The Standard & Poor’s 500-stock index closed on Wednesday with a gain of 11.39 percent for 2014 — 13.68 percent when reinvested dividends are included. It was the third consecutive year that the market benchmark has risen by more than 10 percent.

The run-up has now lasted nearly 70 months, making it the fourth-longest bull market since World War II, according to data from S.&P. (And rich people still hate President Obama? Can you imagine if a President Mitt Romney had this record?)

And after 14 years, the S.&P. 500 finally, in late 2014, rose to a new high on an inflation-adjusted basis, according to data compiled by Professor Robert J. Shiller of Yale.

4. The dollar soared.

5. The outlook for inflation fell.

According to Peter Praet of the European Central Bank, eurozone inflation could be even lower next year than the 0.7 percent forecast by its economists:

Mr. Praet said there was a danger that businesses and consumers were becoming resigned to low growth and low inflation, and as a result were not investing and spending. If so, that would be one of the symptoms of deflation — a broad-based decline in prices that causes people to delay purchases, company profits to sink and unemployment to rise.

Let's take each one of those, one at a time.

I'm going to assume that the economy continues to recover in 2015; not five percent GDP growth like last quarter, maybe, but growth nonetheless. So what happens to these five assumptions?

First of all, oil should rebound in 2015. Come on, did you really think we were going to have oil in the fifties for very long? Even if crude rallies back into the sixties or seventies, that's higher than today. And I'm assuming continued growth, remember?

Second, as a huge bond bear (as I've been reminded by Paul Krugman on an almost weekly basis) I've been wrong, wrong, wrong for about five years now. But interest rates can't stay low forever, especially if the economy continues to grow. If long-term rates climb up to four percent or so, that's still pretty low in my experience.

Three, as someone who has been almost fully invested forever, stocks could stall out this year, especially if oil and interest rates rise in response to a recovering economy. I'm still bullish long term, but "trees don't grow to the sky."

Fourth, I don't really have an opinion on the dollar, but what if Europe and Japan start to grow? Wouldn't that put upward pressure on their currencies? Since they're starting from such low levels, maybe interest rates will rise faster overseas than here.

Finally, since everyone (expect Paul Krugman) has been calling for inflation for the last five years, and everyone keeps getting it wrong, maybe this will be the year prices tick a little higher just as everyone starts worrying about deflation in Europe.

So, are these my predictions for 2015? Not really, but I just like to "expect the unexpected." (Besides, I have nothing else to say this morning.) I'm still wildly bullish on the future; I think Warren Buffett was right when he said at the depths of the Great Recession that you'll be better off at almost any time in the future than you are today.

Happy New Year everyone!

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