It has been a profitable year for stock market investors, with the S&P 500 up about 9% year-to-date.
But given the recent volatility and the steep drop in both equities and crude oil prices recently … many are worried that the best days are behind us.
Yes, the U.S. economy is showing signs of improvement. And sure, after a 30% up year in 2013 and another strong performance in 2014 there are plenty of investors with substantial profits in their portfolios.
But the market can’t go up forever, and 2015 could be a very different story.
If you’re worried that the other shoe is about to drop, or if you’re just an investor looking to hedge your bets against the biggest stock market risks of 2015, take a look at this list of potential problems that could serve as an anchor on the stock market in the new year.
Market Risk #1: Crude Oil
It’s undeniable that the biggest story this December has been the crash in crude oil prices. At under $60 per barrel right now, oil is now almost half of where it was just a few months ago at its summer peak of around $103.
The good news has been a boost in consumer spending as lower gas prices are a boon to family budgets, and of course higher margins for fuel-focused businesses including airline carriers including Southwest Airlines Co. (LUV) and shipping companies like United Parcel Service, Inc. (UPS).
The bad news is that the energy sector has been obliterated, with integrated oil giant Chevron Corporation (CVX) down over 12% in the last month and oilfield service giant Halliburton Company (HAL) down 30% in the same period.
Remember, one of the biggest growth engines of America in the last few years has been the energy sector, with continued job growth and even rare wage growth across the industry. A shakeup in oil could mean a shakeup in the entire sector — which might weigh on U.S. GDP, many investors’ portfolios and consumer trends across 2015 if the energy industry cuts hiring or engages in layoffs.
Market Risk #2: Europe
Goldman Sachs recently highlighted 10 trade ideas for 2015, and one key point was divergence between developed economies. In short, don’t expect Europe to move in lockstep with the U.S. even if domestic growth manages to stay strong.
Consider the recent turmoil in Europe thanks to fears about Greece’s presidential vote and a potential shakeup in policy there that puts the eurozone member once again at risk of a credit crisis.
We’ve been down this road before, and in 2011 things were certainly ugly for the global equities markets thanks to a European debt crisis. Couple Greece’s posturing along with continued fears of deflation on the continent, and it doesn’t look good in 2015.
Equities in lagging markets like Europe could take a serious hit even if there are pockets of strength elsewhere in the developed world or even within the EU. Investors should watch their geographic exposure carefully as some markets significantly lag their peers, but even that may not keep their U.S. positions completely safe in the new year.
Market Risk #3: China
Of course, if you think Europe is bad you shouldn’t even look in the general direction of China.
With just 6% to 7% growth expected — and with a track record of regularly falling guidance — there’s not a lot to be encouraged about in a slowing China. Remember, because of China’s size and hopes for urbanization and a transition to a consumer and service economy, it needs 7.2% gross domestic product growth annually just to create enough jobs for prospective workers.
Throw in the continued risk of a financial crisis and China’s heavy dependence on government spending, and it’s not a pretty picture for this struggling Asia economy.
Sure, a lot of pain is priced in after underperformance in Asia for the last few years. But that’s what some investors said at the beginning of 2014 … and the iShares FTSE/Xinhua China 25 ETF (FXI) has managed to underperform yet again with barely better than break-even returns these last 12 months.
Expect more of the same in the new year — and the risk of spillover into multinationals that rely on China for growth.
Market Risk #4: The Fed
However you feel about the Bernanke and Yellen regimes, it is undeniable that the U.S. Federal Reserve has used remarkable and unprecedented monetary policies over the last few years … and that, while the stock market and economy both seem to be doing much better now than in 2008, the verdict still is out on how America will wean itself off “easy money” policies.
As if things were confusing enough, the drop in oil prices recently adds a lot of uncertainty to what the Federal Reserve will do. Sure, oil has boosted consumer spending in the short-term, but how much strength in the U.S. economy is attributed to energy savings and how much to organic growth? And how will the Fed plot course in 2015 as a result?
As of the end of October, the Fed held almost $4.5 trillion on its balance sheet — roughly double the assets held by the central bank in 2010, and four times the total held before the financial crisis. Where we go from here regarding rates and the sale of those assets remains very much up in the air, even if the recovery thus far has been a success.
And one wrong move — or even one move that’s perceived wrong by traders — could result in a big move down for the stock market in 2015.
Market Risk #5: Strong U.S. Dollar
Another side effect of Fed policy could be a persistently strong dollar — something we’ve already seen for much of 2014.
While it’s all well and good to see the world still confident in the U.S. dollar, the bottom line is that a strong currency hurts the bottom line for many multinationals. A strong dollar makes American exports more expensive in foreign markets with weaker currencies, and unfavorable exchange rates can shave a few percentage points off adjusted sales and profits.
Considering other growth challenges for many companies in 2015 amid a slowing China and Europe, that headwind comes at an inopportune time.
Market Risk #6: Income Investing Pressures
If the Fed does manage to tighten policy without a big impact on the overall economy, it’s undeniable that a higher interest-rate environment will have serious implications for “bond-like stocks” that pay modest dividends right now.
Sure, income investors have flocked to decent dividend payers in consumer staples or utility stocks paying … but what happens if those dividends continue to stagnate, and if the 10-year Treasury note gets up to 3% again, or even 3.5% by the latter part of 2015?
Investors looking for yield with low risk will finally find it again in interest bearing assets — and could rotate a lot of capital out of low-growth, low-dividend stocks like Colgate-Palmolive Company (CL) that that trade for forward price-to-earnings ratios of over 20 right now and yield less than 2%.
Higher rates are, on their face, good for income investors.
But they may be very bad for dividend-paying stocks that no longer offer attractive yields and start to look increasingly risky and overvalued.
Market Risk #7: Geopolitics
The recent hostage crisis in Australia brings home a reminder that terrorist attacks are the norm in today’s world.
And as we’ve seen with unrest from Syria to Israel to Ukraine in 2014, there can be serious economic implications attached to geopolitical unrest — even in less developed regions that are not big players in the global economy just yet.
ISIS remains a serious threat to stability in the Middle East, the situation in Ukraine is no closer to resolution and tensions are high in old hotbeds of violence including Israel and Iran. We avoided serious economic fallout from conflicts in 2014, but we might not be that lucky in 2015.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. As of this writing, he did not hold a position in any of the aforementioned securities. Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP.