This past year was both predictable and unpredictable.  At the end of last year, we anticipated that, if companies were able to sustain their expected growth rates of 10%, we could see the stock market up a similar percentage.  In the end, we were pretty spot on, as the Dow Jones Industrial Average gained about 7.5% while the S&P 500 Index was up 11.4% for the year.   The key reason for this performance was a continuation of solid economic activity here in the U.S.  In addition, while the Federal Reserve finally ended their controversial bond-buying program in October, they have pledged to keep interest rates low, in their words, “for a considerable period”.  This promise of continued low interest rates helped feed the market, though having the Fed stop the bond buying did increase volatility.

In spite of our great prognostication ability at market growth, there were several things that no one could have predicted without looking like an idiot.  For example, no one would have thought that oil, which started the year near $100 per barrel, would finish the year around $50 per barrel.  And who would have thought that the best performing sector in the markets would be utilities – normally a defensive sector in times of recession.  This was an outgrowth of stubbornly low interest rates.  In fact, the yield on a 30-year Treasury bond, which started the year at 3.9%, ended at 2.75% for the year.  Interest rates were supposed to increase, not decrease!

So what do we have to look forward to for 2015?  Will the markets, already at record highs, continue to climb this year?  Will the U.S. economy continue to grow, fueling more earnings growth from companies?   Here are a few things on our radar:

  1.  With oil just below $50 per barrel, we are already seeing companies canceling energy projects.  This will eventually cause oil to find a floor and possibly rebound, though $100 oil is not likely any time soon.  This will be a net positive for the economy, as fuel prices have fallen dramatically, but there will be job losses, too.  The net effect is a little murky.
  2. Greece is again in the news (much like two years ago) with an election.  There is another need for a Greek bailout and the threat of Greece leaving the Euro.  Frankly, the Euro has held up as a currency longer than I ever expected, so I would not be surprised if Greece exits and others follow suit down the road.
  3. Slowing growth in China – growth largely supported by excess government spending – could cause a slowdown in U.S. growth.
  4. There is a chance for increased volatility around the Fed’s first rate hike.  While this is widely anticipated and one of the most telegraphed hikes in history, there could still be some jitters.
  5. There is almost certain to be more volatility in the stock market than we have seen in the past few years.  One key reason for this is the ending of the QE bond-buying program by the Fed.  This program continued to pump cash into the financial system, which, rather than find its way to capital investments by companies as hoped for, managed to find its way into the stock markets.  With this source of liquidity gone, we will return to a more normal level of volatility in the stock market, though that make take a bit getting used to again.  It is a bit like being on land too long and then heading back out to sea.  It takes a bit to get your sea legs under you.
  6. There is always the threat of a “black swan” event that no one sees coming.  Markets hate uncertainty and there are enough “hot spots” around the globe to fuel plenty of fear and uncertainty.  With North Korea, Russia, ISIS (or ISIL), Iraq, Syria and who knows what else is brewing that has not made headlines yet, there is plenty to be cautious about.

With all of those issues, one could easily be pessimistic.  I am more optimistic.  While I do not discount the risks I have enumerated above, there is still a lot to like about the markets and stocks in general.  This is especially true if the focus is on the right area.  Many of the stocks that did best for us last year did well regardless of what happened in the world.  Some of our best performers included Fisher nut producer John B. Sanfilippo & Son (JBSS), UnitedHealth Group (UNH) and Kayne Anderson Energy (KED), which holds shares in a number of oil and gas pipeline partnerships that make money for simply transporting these commodities around the country.  Do you see a common theme here?  They are all focused on the U.S.

I have been focusing on U.S. companies, lately.  There is still room for growth left in our economy and this will continue to feed earnings.  This does not mean there are not risks.  In spite of great job growth over the past year, when the U.S. economy added almost 3 million jobs, there is anecdotal evidence of labor shortages among skilled workers.  The unemployment rate that I prefer to look at, called the U-6 rate, also measures underemployed and people who no longer “officially” counted.  This has fallen to 11.1% as of the end of December, down from 13% at the end of 2013, but still well above its long-term trend line around 9% annually.  So there is still room for job growth.  The question is, do these workers have the right skill set for the jobs we need.  As long as job growth can continue and the economy gets boosts like lower oil prices (more money in people’s pockets), we should continue to see earnings growth among companies.

As always, we do truly appreciate the trust that you have placed in us with a portion of your assets.   If you have any questions or need to discuss any issues, please feel free to give us a call.

Alan R. Myers, CFA
President / Senior Portfolio Manager
Aerie Capital Management, LLC
(410) 864-8746
(866) 857-4095