We’re halfway through 2015, and the S&P 500 is sitting on a rather ho-hum return of less than 1%.
Of course, even that fractional gain hasn’t come without drama. The market has meandered up and down since Jan. 1 thanks to negative headlines like slowing growth in China and concerns of a GDP contraction in the U.S., but also optimism as labor numbers continue to plod higher and low energy prices put more money in consumers’ pockets.
But past is rarely precedent, and as we close the books on the first half of the year, it’s also useful to think critically about where the market and the global economy will be headed in coming months.
There are no guarantees, of course, and even the best-intentioned forecasters are frequently proven dead wrong.
But that’s a risk I’m willing to take!
So let me share with you what I think the biggest stories of the second half of 2015 will be, and what investors should be paying attention to as we enter Q3.
U.S. Growth Will Be Strong
The year got off to a bumpy start after a GDP contraction in the first quarter. As a result, the alarmists came out in full force with their recession calls.
But if the first half was characterized by disappointment, the second half of 2015 will be characterized by acceleration.
For starters, some of the details from those early months hint at delayed economic activity — not lost activity. Consider the very slow inventory build in Q1 as a perfect example. We’ve seen this movie before, including an initial 2.9% rate of decline in Q1 2014 — the most in five years — that sparked similar doomsday calls … but that was eventually revised to just a 2.1% decline and was followed by a very brisk 4.6% pace in Q2.
But don’t just take my word for it. Goldman Sachs recently revised its full-year GDP target higher and is expecting a 3% pace of growth in the second half. Also, Merrill Lynch just revised up its 2015 forecast to 2.9% from 2.3% growth. And while the World Bank wasn’t quite so hot, recently revising down its forecast of U.S. growth, the agency still is plotting a 2.7% growth rate for 2015 even after a weak start to the year.
In short, expect a powerful finish to the year despite a slow start to 2015.
10-Year Treasury Rates Won’t Finish Over 2.5%
Click to Enlarge While economic activity is looking up, there isn’t quite the activity that there should be for the Federal Reserve to have confidence in a rate hike. That’s evidenced by the fact that anticipation of a midyear rate hike has been replaced by feelings that an increase will come in September at the soonest.
But keep in mind that the market has been jumping the gun on rates for some time.
Consider that in March, the Fed released a “dot plot” (at right) to show where FOMC participants expect rates to be in the near future. In this report, 10 out of 17 Fed members predicted the benchmark federal funds rates would be at 0.5% or lower through 2015.
But compare that most recent dot plot vs. one from December 2014, which showed just four FOMC participants predicting fed funds rates of 0.5% or less in 2015. In fact, back in December, a majority (9 of 17) expected fed funds to top 1% in 2015.
Click to Enlarge Everybody making rate forecasts over the past decade or so has been way off the mark. As you can see by this chart, typical 12-month forecasts for where rates will be are about 60 basis points too high.
So if the consensus prediction is for rates to be at 50 basis points, fed funds in fact could be unchanged even into next year.
If you need proof the Fed isn’t eager, just consider comments from William Dudley, president of the Federal Reserve Bank of New York, who said about rates, “There are reasons to err on the side of being late than being early.”
We’ve already seen rates move higher, and there could be a continued short-term uptrend to 2.5% on the 10-year Treasury or even slightly higher. But I do not anticipate aggressive tightening by the Fed, nor do I expect the rate to stay above 2.5% very long.
Europe Won’t Implode
Click to Enlarge The ongoing debt crisis in Greece — you can check out Greece’s hefty repayment schedule, courtesy of the BBC, to the right — has resulted in fits and starts of negotiations that seem to go nowhere, and talk of a “Grexit” from the eurozone continues.
But fears of a disintegration of Europe thanks to this tiny economy making a lot of fuss are grossly overblown.
For starters, there is a massive practical impediment to any Grexit — the fact that the majority of residents in Greece want a deal with the EU and IMF, and have no desire to go it alone.
Beyond that, even if some type of meltdown occurs, Greece’s economy isn’t even in the top 40, according to IMF data, making it smaller than the Philippines or Chile.
Heck, Argentina’s economy is roughly twice the size of Greece … and its debt default didn’t cause the end of Western civilization.
There are certainly challenges in Europe as it relates to the challenges of the eurozone structure. But most of the political posturing by member states, from Greece to Germany to even Britain in the wake of recent elections, is all simply that: political posturing.
The bluster makes for good headlines, but it’s all a negotiation for terms. And ultimately, Greece and the EU will survive and move forward.
China, on the Other Hand …
Click to Enlarge While I don’t think there are signs of trouble in the West, China is a disaster waiting to happen — for a host of reasons.
There has been a huge run-up in Chinese stocks lately on hopes of a stimulus juicing the economy. But as a result, there has been a stampede of buying that has resulted in tremendous froth.
The vertical climb in stocks has created bubble-like valuations — including tech stocks that trade for more than 220 forward earnings on average!
There’s also a staggering increase in margin debt as Chinese investors borrow tons of money to get into the “sure thing” that is the stock market. Money-hungry corporations are also racing to get in on the party, with a frantic IPO pace that has delivered 225 new companies to market since January 2014 — with an average performance of over 400% since they hit public markets!
This, even as A-shares listed on Shanghai and Shenzhen exchanges are predicted to have the lowest earnings growth in three years — with the financial sector, struggling amid bad debts, acting as one of the biggest drags.
None of that is good. But throw in the general untrustworthiness and opacity of China’s command-and-control government, and it’s very difficult to think this will end well.
There may be a way for China to avoid disaster for the short term. After all, its central bank has cut rates three times in the past six months and is launching stimulus “to help local governments restructure trillions of dollars in debts.”
But this party can’t rage on forever. And by the end of 2015, I expect reality to settle in and create serious pain for Chinese stocks — and investors who hold them.
The Top Calls Will Keep Coming … Even as Stocks Stay Strong
Click to Enlarge Now that all the macro stuff is aside, you’re probably saying, “Yeah, but what about my portfolio?”
The short answer: Not much. Stay the course, with an eye toward responsible long-term growth, and you’ll be fine.
Consider that volatility is at a historic low in 2015, and that history shows that a sustained drop in such an environment is unlikely — and while there have been similar markets where a deep temporary decline occurs, such as in 2001, the market does indeed bounce back quickly.
In fact, history shows that it’s not uncommon for there to be substantive intrayear declines … which mitigate significantly if not entirely by year’s end. Case in point, the JPMorgan chart above plotting what the worst temporary decline was in each of the last several years versus where the market actually ended up on Dec. 31.
Perhaps the most important data point of all for the bears to remember is that rallies do not end simply because they’ve gone on for a few years and are “due” to result in a reversal. Consider the raging bull market of 1987 to 2000, which lasted 4,494 days and saw a roughly 585% increase in the S&P 500!
I would never discourage investors from thinking critically or skeptically about the numbers, and it’s admittedly human nature to wonder when the party is going to end.
But predicting the end just because we’ve had a long run-up, especially in the face of this encouraging data? That’s just self-defeating.
Forecasting is hardly an exact science, of course, and there could always be an exception to all this with a big move down in 2015 that keeps investors underwater the rest of the year. But even so, long-term investment in equities is a wise idea for almost every investor of every stripe.
After all, Wall Street is littered with the corpses of top-callers who were painfully wrong. I wouldn’t be eager to join those ranks if I were you.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. Write him at [email protected] or follow him on Twitter via @JeffReevesIP. As of this writing, he did not hold a position in any of the aforementioned securities.