Investment Directions Market Outlook
Central Bank Divergence
As the Federal Reserve (Fed) ends monetary easing and is set to raise rates sometime in mid-2015, the European Central Bank (ECB) and Bank of Japan (BoJ) are moving toward more easing. Short-term bonds should feel the impact of rate increases more than long-term bonds, as lower rates in Europe and Japan increase demand for long-term U.S. bonds with relatively more attractive yields. That, as well as several secular trends, will likely keep long-term U.S. bond yields low relative to history.
Expect a Stronger Dollar
Divergent central bank policies support a stronger dollar, with a number of implications, including lower oil prices, which benefits oil-importing countries like China, India and Japan.
U.S. Economy Leads the Pack
We believe the U.S. economy will show gross domestic product (GDP) growth in the area of 2.5% to 3% in 2015. While the U.S. economy is not without its challenges (labor participation is still low), it is in a better position than other developed markets. Perhaps the biggest challenge facing the U.S. economy is weaker growth overseas.
Be Prepared for Higher Volatility
Volatility, as measured by the VIX Index, is still well below its historical average, as was the case for most of 2014 (with a few notable exceptions, such as autumn). With the Fed ready to change tack, the economy struggling in Europe and geopolitical tensions in places like Ukraine, we expect higher volatility in 2015.
The Bottom Line
We continue to prefer stocks over bonds and cash, even with volatility expected to rise. We would focus on opportunities in certain international markets and cyclical sectors. Japan remains the most attractively priced developed market, with catalysts for further stock gains on the horizon.