2014 -- 51 -- Year End Review 01

At the end of each year, it is my tradition to review the markets for the year and then provide some thoughts on what to expect the following year. This week I will review 2014, and next week I’ll take the risk of providing a forecast for 2015.

The most surprising economic story of 2014 was the rapid drop in oil prices since mid-summer. After peaking at about $108 per barrel, oil prices have dropped almost 50%, to $55 per barrel.

  • The positive side to this drop is that it has been driven by increased oil production in the U.S. and Canada. As a result, the influence of OPEC and other nations on the world economy has decreased. This trend is probably permanent which is a very good thing.
  • The price drop has also had a positive effect on the U.S. economy and that of other developed nations in that it acts a tax cut and stimulates the economy. This means that, despite increasing taxes in the U.S., the drop in energy prices has provided extra disposable income for the average family. While this impact will be much less than widely-followed economists will predict, it will help the slow recovery.
    • Unfortunately when oil prices inevitably go up in the future, this positive effect will be reversed.
  • At the same time, the severity and speed of the oil price drop has caused serious challenges for many economies around the world. The most notable country that has been affected is Russia. While, on the surface, it is fun to celebrate the serious economic problems in Russia, a longer term view suggests caution. An unhappy Russia, both its persecuted people and its conquest-driven leader, is a dangerous Russia. More on this issue next week when I forecast 2015.

Less surprising, but at least unexpected, was the continued decline or lack of a rise in interest rates. Short term interest rates have again dropped to the near zero range. Mortgage rates remain historically low. While longer term rates have risen slightly, their rise has been modest compared to historical norms this far into an economic recovery. There are several reasons why interest rates are low and, at times, continue to fall:

  • The Federal Reserve continues to be obsessed with the potential for worldwide deflation. This is a good thing since a significant part of the world economy is either contracting or going into a recession. Many European countries, plus Russia, are in recession or worse and are experiencing deflation as part of their economic slowdowns.
  • Europe is close to or already into a deflationary recession. This is, in large part, due to the continuation of tight money policies by German leaders. They continue to restrict money supply due to an irrational fear of inflation. Hopefully they will abandon their Herbert Hoover-ish policies before they drive all of Europe to deflationary pain.

The stock market is completing another record year of continued increases. Of course, there were a few minor corrections thrown in, seemingly for short term entertainment purposes. In spite of these, we are ending the fifth year of a rising market. The longer this lasts, the scarier and larger the eventual decline will be.

Each year the threat of a decline in the U.S. stock market gets larger. But the stock market continues to go up for the following reasons:

  • Friendly Fed.The Janet Yellen-led Federal Reserve reiterated its “lower for longer” message for interest rates last week. The Fed coined a new expression — “patient” — to describe the way they will pursue the transition to higher rates next year. This means that they will wait until the economy is very strong and there are obvious signs of wage growth and inflation before increasing interest rates.
  • No alternatives market. The continuing rally in the U.S. stock market is being driven by the same factor — there really is no other place to make money. Interest rates continue to be so low that there is no reason to be in bonds due to the low prospective returns and the risk of principal loss that is inevitable unless we have a deflationary recession/depression.
  • As mentioned above, the sharp drop in oil prices has been a boost to the economy. This will help economic growth in the first half of 2015, thereby increasing earnings for large corporations.
  • The amount of public stock available has declined in 2014, and continues to decline. Low interest rates create a ripe environment for takeovers. Because of this, 2014 has been a good year for mergers and acquisitions. When companies are acquired, the supply of stock is reduced. This accelerates the demand for stocks in the no-alternatives stock market.
  • The Republican gains in the November elections and the increasing unpopularity of Obama have encouraged investors that there is an end in sight to the unfriendly regulatory environment that was put in place by Obama and his anti-business cronies.

How long will the stock market stay strong? Not forever, but probably longer than most people expect.

Next week I will comment on what I expect for 2015 for the markets, the economy and events in both the U.S. and the world.

In closing, I wish you and your family a wonderful Christmas and holiday season. Cherish those you love, and find some special way to tell your loved ones how much you love them as you enjoy the holiday season.