Things have been easy for the stock market lately. Since late 2012, gains have been fueled by the retreat of potentially negative catalysts — such as a breakup of the eurozone or a U.S. debt default — and the copious application of cheap-money stimulus from the major central banks.
But 2015 is shaping up to be a much more treacherous environment as a number of issues come to a head. This means that investors, for the first time in years, might be subject to some uncomfortable price volatility.
Here are five things to keep an eye on in the new year.
Partisan gamesmanship will return to Washington on Jan. 3 as Republicans take control of the Senate, and expand their grip on the House of Representatives, while the 114th Congress begins its work.
The first item of action appears to be legislation concerning the Keystone XL oil pipeline. But also at the top of the list will be the GOP’s response to President Obama’s executive action on immigration, with the first battleground being the funding for the Department of Homeland Security.
The bickering could very well continue into March, when the U.S. Treasury’s debt ceiling comes back into play. It’s worth remembering that the most severe pullback of the bull market to date was a direct result of the GOP’s takeover of the House in the 2010 midterm elections, which resulted in the budget battles of the summer of 2011 and the downgrading of America’s credit rating by Standard & Poor’s that August.
As things stand now, sometime in the middle of 2015 the Federal Reserve will raise interest rates for the first time since 2006 — ending what will be an eight-year-long run of rates near zero percent. This is in response to the impressive job gains and economic growth we’ve seen recently.
And it comes on the heels of October’s end to the latest bond buying stimulus program, which was started in 2012.
No one really knows what will happen when the Fed starts tightening policy. The response to the 2008 financial crisis and the recession that resulted, the worst downturn since the Great Depression, has been creative and aggressive. And it was also unprecedented, taking the Fed’s monetary base from $800 billion to near $4 trillion now.
The combination of pricier credit, and bond price declines (as rates rise), could be unsettling.
The main event in the months to come will be what happens in Europe, as the eurozone economies are slowing and political turbulence returns to Athens. The European Central Bank was able to tamp down eurozone borrowing costs, and restore confidence, in 2012 thanks to a vague commitment to buy government bonds of countries like Spain and Italy should the need materialize. Other efforts included three-year bank loans and targeted bond purchases.
But the structural problems of over indebtedness, lost economic competiveness, and the haranguing a strong euro has caused countries like Greece and Spain, were never addressed. Should the anti-bailout Syriza party win upcoming elections in Greece, and should the ECB fail to deliver the government bond purchase stimulus the market expects, confidence could quickly unravel.
Click to Enlarge Since the stock market’s smooth uptrend started in late 2012, investors have gotten used to a steady decline in market-based volatility expectations. Many have made money betting against volatility, using vehicles such as the VelocityShares Daily Inverse VIX Short-Term ETN (XIV), which rose roughly 140% between the end of 2012 and the peak in the NYSE Composite Index back in July.
But now, volatility seems to have entered a new period of strength heading into an uncertain year. The leveraged VelocityShares Daily 2x VIX Short-Term ETN (TVIX) positions I’ve recommended to Edge subscribers are already up more than 20% since the beginning of December.
Click to Enlarge Commodity prices have been hammered lately, largely thanks to the halving of energy prices over the past six months. As a result, the prices of stocks and commodities — which normally tend to move in unison — have disconnected to an extent not seen since 1998. That year featured a large decline in oil prices and a corporate profits recession (as energy companies were hit).
While many have dismissed the drop in oil prices as a glut of supply, given OPEC’s recent decision to maintain production levels, a slowdown in global economic growth has played a larger role as demand for energy has diminished. This suggests that commodity prices are warning of a slowdown that stocks seem to be ignoring.