The big market stories over the course of 2014 were Oil, the US dollar and surging U.S. equities. The Russian ruble tumbled to record lows in December, and as of this writing continues to weaken, but the U.S market's meteoric rise appears to be unstoppable.
As 2014 comes to a close we asked 10 of the most popular contributors to Investing.com for their strategies for the coming year. We received a provocative mix of views and have divided the responses into two articles. In Part I, here, opinions ranged from the macro to instrument specific convictions. Part II, below, offers insight into what contrarians are considering.
The infinitely quotable American author Mark Twain once counseled, “Whenever you find yourself on the side of the majority, it is time to pause and reflect.” This is, of course, great advice for life on the whole, but it has very specific applications to trading in particular. As of writing, the consensus 2015 trade in the forex market is to be short EUR/USD. At first glance, this is a very logical position: the US economy is accelerating, prompting speculation that the Federal Reserve will hike rates in the first six months of 2015, while the Eurozone is struggling with lackluster growth and fears of outright deflation, with most traders pricing in the start of sovereign quantitative easing (QE) program from the Eurozone in Q1.
The problem with this view is that the impact of these bearish catalysts for EUR/USD may be priced into the market already. The pair has already fallen a staggering 1,800 pips in the last seven months of 2014, and sentiment is near an historic bearish extreme. The CFTC’s Commitment of Trader data shows that speculative futures traders are net short EUR/USD to the tune of 200,000 contracts, the most extreme positioning since the May 2012 low. With rates testing a decade-long bullish trend line in the lower-1.20s, it’s worthwhile to wonder if everyone who was considering selling already has.
As Mark Twain noted a century ago, the consensus is a dangerous place to be, and EUR/USD could prove that adage by rallying strongly in 2015.
While it is likely to be a grind until it finds an ultimate bottom, I believe that one of those most out-of-favor sectors—the gold miners—is likely to provide a rewarding opportunity at some point in 2015 and beyond. This is not simply because the sector has been beaten down. That is not a basis for investment. The potentially compelling issue is that of an environment seeing global economic deceleration and a lack of inflationary effects on asset markets (i.e. commodities and many emerging markets are dropping). This is manifesting in gold out-performing most commodities and if/as it does so in relation to developed global stock markets, the stage would be set for investment in gold mining companies of relative quality.
The key is not to chase inflation around when considering gold stocks. It is to watch gold vs. mining cost inputs, including human resources and expectations for prosperity (i.e. economic growth, the stock market, etc.). Gold vs. crude oil and energy resources has been rising sharply. That is a positive in that the mining 'product' is out performing a mining 'cost'. Watch gold in relation to the stock market—particularly the US—for a time when investor psychology may be ready for a turn as well. After all, when the S&P 500 is flying around at all time highs, the majority have no inclination to look at a contrary play like the gold sector. Several macro indicators are coming in line, but gold vs. the stock market has been a holdout. At such time as gold rises in S&P 500 units, a new bull phase in the miners would be indicated, assuming of course that gold is still elevated vs. energy and commodities.
Without question, I believe the most attractive returns in 2015 will be found in the oil and gas industry, particularly among the integrated oils and particularly by using the approach I discuss below.
OPEC has painted itself into a corner. Oil was in moderate over-supply vs. demand prior to the OPEC meeting. That was hardly an issue since winter is coming to the Northern Hemisphere, where the bulk of manufacturing nations are, thus where most oil is consumed.
Since OPEC and all other producing nations are now continuing to create over-supply, the price of oil has plunged. There is no next move for OPEC. Its members are living in the 1970s when it had the power to bring the more-developed oil-consuming world to its knees. Nigeria, Venezuela, Iran, and Russia are only the most obvious cases today of mismanaged economies with incompetent or fraudulent authoritarian governments. Lower prices will create at best riots in their streets and at worst (for them) messy regime change with the likelihood of severe interruptions in global oil supply.
Further, thanks to US, UK, Norwegian et al entrepreneurship and innovation, the cost of finding and producing oil is plunging. The question we should ask is not "Will oil prices stay this low?" but "Can US producers make money at these levels?" Every day our producers get more efficient; every day the cost of keeping shaky OPEC regimes in power grows. They must buy their citizens' quiescense with food, shelter, education and energy subsidies; make-work jobs for 10 that would be done by one in the US; graft, corruption, nepotism and baksheesh at all levels of society; and lavish lifestyles for those whose only qualifications for leadership positions was being born to the already-in-power parents. It costs even Saudi Arabia, which can "pump oil" at $7 a barrel, almost $100 a barrel to provide all those subsidies and baksheesh.
We are playing the likelihood of OPEC's disintegration or descent into insignificance by purchasing long-dated calls (LEAPs) on the big integrated oils and ETFs like the SPDR Energy Select Sector Fund (ARCA:XLE). This way, we deploy very little capital, gain great leverage, and can never lose more than our small investment. It's possible oil companies will remain where they are or decline over the next two years. Anything's possible. I just believe it's highly unlikely!
The consensus expects 2015 to be a glorious year for equities. This is the fabled 'Year 3' of the Presidential Cycle. The S&P has risen 22% on average in these years, and it has never produced a negative return in the past 60 years (charts). But we think 2015 will end up being an unglamorous year for US equities.
For the past 3 years, equity prices have run up much faster than either corporate revenues or earnings. This makes them expensive on any number of metrics. Price/sales ratios, for example, are nearing the highs from 2000. The remarkable run higher in equities has also made investors sanguine about future appreciation. Contrarians take note: retail investors have a greater allocation in stocks now than at any time other than during the late tech bubble period from 1998-2001 (charts).
If that were all to the story then equities would be in for a fall in 2015. But the conundrum for bears is that the US economy continues to strengthen and corporate financial results are excellent. November industrial production was arguably the strongest in 15 years and the latest employment report was the best since early 2012. As a result, revenues for US companies are accelerating, to nearly 4% from about 2.7% just a year ago (charts).
So, the likely set-up heading into 2015 is one where equity appreciation takes a pause while the real economy catches up. We’ve seen this many times before, most recently in 2011, but also in 1984, 1994 and 2004-05. Each of these years gained little from start to end but experienced strong intra-year drawdowns. The S&P 500 has not had a multi-month drawdown of more than 10% in two and half years. That opportunity is likely to arrive in 2015. This implies a retrace to 1900 or less for the S&P 500. That would reset investor sentiment and valuations and also be a profitable entry point into SPDR S&P 500 (ARCA:SPY).
The most widely hated asset class continues to be Treasuries. In a Wall Street Journal poll of big investors, 90% said they are bearish on Treasuries and only 5% said they expect U.S. 10-Year yields under 2.5% in 2015. They are currently 2.1% and declining. Even so, yields in Germany and Japan are about 170 basis points lower. The fall in oil prices is another tailwind for Treasury prices. Inflation is tame, making the Fed unlikely to raise rates anytime in 2015. iShares Barclays 20+ Year Treasury (ARCA:TLT) outperformed SPY in 2014 and will probably do so again in 2015.
One final idea is emerging markets. The price of these markets has fallen by about 20% in 4 months. The price of oil is the primary culprit. Current valuations relative to developed markets are similar to the lows in 2004 and 2009. Global investors are very underweight the region. If the price of oil firms, iShares MSCI Emerging Markets (ARCA:EEM) would likely strongly outperform SPY in 2015.
The current state of financial markets is quite interesting. Central banks have been in full stimulus mode, artificially propping up the financial system for a while now. I hope the majority of readers understand that we're living on borrowed time during the current bull market, however it can continue for a year or two. We have all major central banks—especially the Fed and the BoJ—engaged in extremely dovish monetary policies. While the Fed has paused its QE program right now, we have the ECB signalling they are ready to undertake QE in early 2015. Moreover, the BoJ recently doubled down on its QE. These insane policies, which were completely unimagined only several years ago, have benefited a variety of asset classes around the world, and in particular developed market equities in the last few years.
Personally, I am interested in investing in equities for the next few quarters as long as the party continues. However I do not like buying high and selling low later down the track. Therefore, markets such as US large caps (S&P 500) seem overvalued to me on many different metrics. While they might continue to rally and become even more overvalued, I would prefer to be invested in markets that have lagged behind and appear to be cheap. With that in mind, recently I have opened up a very substantial position into Chinese equities (via iShares iShares FTSE/Xinhua China 25 Index (ARCA:FXI)). The possibility of further interest rate cuts by the PBOC and the current crash in Crude Oil, could benefit the economy and push stocks higher there.
When it comes to other asset classes, I continue to hold all of my cash in US dollars. The USD Index has been through a very powerful rally. Entering into 2015, we could easily see a shake-out in the form of a meaningful correction, as many hedge funds hold large net long positions. However, eventually the dollar should continue its run for a while longer, because the world will continue its easing programs weakening their own currencies. As an alternative to the dollar, I would consider starting a Precious Metals long position, (via Central Fund of Canada Ltd (ARCA:CEF)), since they are extremely oversold and edging into their 4th year of being in a downtrend. While the bottom might not be here just yet, Gold at around $1000 per ounce offers great value for the long run.
Finally, the contrarian trade of the year would have to be Russian equities (via MarketVectors TR Russia ETF (NYSE:RSX), which have suffered a terrible 2014 for many reasons, including a crash in Oil prices and the ruble's insane devaluation. If you believe in buying low and dirt cheap, this market trades below half of its book value. I would wait until RSX retests its 2008/09 low, where technically a major support exists. This is a great bet on recovery in energy prices, if you believe Oil will not stay below $60 forever. I certainly don’t…
The end of 2014 has certainly been very different from the start, with markets refusing to end the year on a benign and relaxed tone, delivering instead periodic bouts of violent volatility, which at times has been off the Richter scale. In addition we have also seen a breakdown of many of the traditional and reliable relationships and correlations, thereby making any forecast of what is likely to happen next year about as easy as trying to forecast the latest lottery numbers.
However, anticipate and forecast we must, because volatility eventually dies down, and relationships reconnect and repair. But where to start? Perhaps we should scroll back to the beginning of 2014 when many analysts and commentators were declaring this to be the year of the US dollar. And indeed, after a very slow start the USD duly started to move higher in June when the Dollar Index failed to take out the strong platform of support in the 79 price region, and so began its current ascent. Since June the USD index has been on an unbroken upward trajectory as it now moves towards the key 90 price point. Only a move through this region will see the USD index re-test the 2005 high of 92.
However, any move higher for the USD has ramifications for other instruments and asset classes, not least commodities and emerging markets, and it is the latter and the events of 1998 which are likely to weigh heavily in 2015. For a view of the overall performance of emerging markets the iShares MSCI Emerging Markets ETF (ARCA:EEM) is a good chart to follow and here the technical picture looks weak longer term, with the ETF having been in congestion for the past 2 years, mirroring the USD index. Any move through the floor of support in the 36.50 could then trigger a deeper move to the lows of 2009.
The prospect for further dollar gains looks compelling. First the technical picture is now building a strong base and provided the 90 region is taken out, we can expect to see a further move to test 92 and from there on possibly even towards 94.70 by the end of the year. In this respect much will depend on the continuing positive rhetoric from the Federal Reserve. With interest rates now increasingly taking centre stage once again, the main beneficiary will be the US dollar. Indeed this could be one of the characteristics of 2015, where the fundamentals play an increasingly important role, particularly in forex markets, with central bank management of rates taking a back seat. This in turn is likely to be reflected in the major currency pairs as interest rate differentials once again become the main drivers of this market with Europe languishing in recession, if not outright depression.
Before moving to other asset classes, the US dollar’s celestial twin is, of course the Japanese yen, and here 2015 may be the year that Japan loses control of their currency. 2015 may be the year the BOJ takes a step too far in its constant round of quantitative easing. With the 120 price level having now been pierced the next significant level is 125 with 134.50 the next logical step.
Moving to commodities, here it has been a dismal year for Gold bugs with the precious metal declining steadily, punctuated with minor rallies. The outlook for next year is more of the same, with gold likely to move through $1100 per ounce and possibly to test the 2009 levels of $1000 per ounce in this period.
Furthermore, the traditional correlations for gold with the US dollar as a safe haven appear to have broken down, with the metal trading in its own unique world. Silver is likely to mirror the price action for gold.
The collapse in oil for both Brent and WTI has been dramatic and mirrors the equally dramatic fall of 2008, at the height of the financial crisis. The cause of the current fall is all to do with politics and in particular the desire of OPEC to curb the rise of alternative energy suppliers and sources. The fallout from the collapse in oil prices, particularly for the more junior members of OPEC, is already leading to social unrest and regime change. The break-even prices have already been exceeded, but we are not at the bottom yet and we can expect to see a further move lower for oil early in 2015, with a consequent bottom likely in the $40 per barrel region for WTI.
Moving to equity markets, the Philippines was once again the star performer, with the iShares MSCI Philippines ETF (NYSE:EPHE) returning 31% against the US at 17.9%. This is a perfect example of how the media fails to report wonderful trading and investing opportunities in other markets.
Other star performers in 2014 included India, Indonesia, Taiwan and Vietnam and these countries look set to deliver another strong performance in 2015 as they will benefit from cheaper energy costs. Bottom of the list is Russia - which is no great surprise - given the collapse in oil prices and the ruble.
In summary, 2015 will deliver some great trading and investing opportunities and may the year to look beyond the more traditional asset classes and instruments.
To read Part I, Market Outlook: Overvalued Markets, Strong USD, Oil Will Hit Bottom, click here.
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