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The fourth quarter of 2014 was characterized by a sharp downturn in the price of oil and two market swoons with high volatility. Stock market pullbacks have corresponded with selloffs in oil, and have rebounded each time. This has not derailed the bullish trend, but has added a few question marks to the outlook. A robust U.S. economy is now in stark contrast to the rest of the global economy, which is still slowing with persistence. The U.S. economy expanded at a 5% rate in the third quarter, a rate of growth not seen since 2003. Consumer confidence is at levels not seen since 2007 and is still climbing, while U.S. car sales are expected to hit record highs in 2015.
A 60% pullback in oil prices from their highs last June has also had the impact of rallying the U.S. dollar, since oil is priced in dollars. Furthermore, the dollar has rallied due to perceptions that the United States is finally going to raise interest rates later this year, and over concerns about Greece’s future in the Eurozone following January 2015 elections. With a higher dollar, imports become cheaper to Americans, which is a form of imported deflation.
Deflation is now a reality in Europe, where overall prices contracted by 0.2% in December. Even in the U.S., inflation, at 1.3%, is well below the 2% target set by the Federal Reserve. In China, inflation has slowed to 1.4%, its lowest since the 2009 recession, stoking fears of a deflationary spiral. The selloff in oil prices will have a further dampening effect on inflation, which explains why bond yields have been declining. U.S. 10 year yields have dipped below 2% for the first time ever, while 5 year German and Swiss bonds now yield nothing. Japanese 10 year bonds yield an almost nonexistent 0.28%. The bond market seems to be indicating meager prospects for economic growth. Japan’s economy slipped into a recession in the third quarter of 2014.
And yet the IMF estimates that with oil prices at current levels, global GDP should receive a boost of 0.3% to 0.7%, which is a tremendous tailwind akin to a global cut in taxes.
The European Central Bank is now expected to enter into a massive stimulus package involving an extensive quantitative easing by the end of January. If this comes to pass, then low oil prices and a low Euro should finally begin having a positive impact on the Eurozone economy. As for Greece, a coalition government is the most likely outcome for the January elections, which should reduce fears of a Greek exit from the Euro. The E.U. is also likely to offer Greece some debt relief in the first quarter of 2015, which will serve to stabilize the Euro’s decline.
The IMF believes that the world economy will grow by 4% in 2015. Economies with a lot of slack have room for above-normal growth. Interest rates, both short-term and long-term, are low, private debt has vastly decreased, and fiscal deficits are under control. If the European Central Bank delivers on a major quantitative easing program later this month, there could be a disproportionate and unexpected rise in confidence that would rally world stock markets.
The Chinese Central Bank has already begun stimulating their economy by embarking on an interest rate cut cycle in November. China is the world’s largest net importer of oil, and fall in energy prices will be hugely beneficial, leading some economists to conclude that every 10% drop in oil prices will boost China’s GDP growth by 0.15%.
Three out of four of the world’s largest central banks are either holding interest rates steady or reducing them, which will increase liquidity in the markets in 2015. Earnings at U.S. companies are likely to continue to grow this year, and stock valuations are still attractive relative to historical levels. However, 2015 is likely to begin a tightening period for monetary policy. As interest rates begin to normalize, the stock market may be in for increased volatility. The greatest risk to the stock market is either inaction on the part of the European Central Bank or much higher interest rate hikes in the U.S. than expected.

For the year 2014, The Dow was up 7.52%, the S&P 500 was up 11.39%; and the Nasdaq was up 13.39%.
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Grant Rogers

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