The internet has plenty of articles discussing what may be in store for stocks in 2015, and they all disagree with each other. Some are bullish on the U.S. with falling oil, while others are insistent that valuations are too high; with a TTM P/E ratio over 20 for the S&P 500 (SPY), it’s easy to argue that valuations are lofty. Likewise, falling oil does seem like a discount for consumers that will boost discretionary spending, which is why the consumer discretionary ETFs (XLY, XRT) have soared over 18% in the past two months, despite their relatively low volatility.
The reality is that no one really knows what will happen to stocks next year, and institutional investors are less interested in the predictions of outperformance than in the risks on the horizon for their clients’ portfolios. Again, many predictions abound; tensions with Russia, falling growth in China, QE in Japan, and deflation in Europe are all cited as risk factors for the bears.
A good analyst will consider all of these in a macro view when establishing a perspective for the coming year, but an even better analyst will be willing to change that macro view as soon as new information comes to light. Geopolitical situations can change at the drop of a hat, especially now when they hinge on politically unstable regions. Likewise, a sudden shock to the system like the falling price of oil can change countries’ diplomatic policies and relationships, in turn impacting their equity markets. A constant update is essential, as is an open mind to how new developments will influence things.
While all investors keep a close eye on oil, Russia, the eurozone, and other large themes, value investors continue to look at the fundamentals. These remain good in the U.S., as most S&P 500 companies beat earnings expectations in most quarters in 2014, and the forward P/E ratio for the index remains around 17 or 18, depending on your estimates. American GDP growth clocked in at 5% by the last estimate, far beyond expectations and well above developed economy norms. That’s exponentially higher than the anemic eurozone, and only about 2.3 percentage points behind China. The gap between the U.S. and developing countries has never been so small.
There is a back office story that professional money managers and institutional investors need to concern themselves with. While the stock market is up, Wall Street itself is down; brokerages, money managers, and the once invincible hedge funds have seen their own revenues fall by about 10% across the board. More people are pulling money from institutional, active managers and into passive index funds. The belief that no one can outperform the market is getting more widespread, and a misunderstanding of the purpose and performance of hedge funds means that many are pulling their money out of these finds.
This was the story of 2013 and 2014, and many are hoping it will change in 2015. The money supply grew and depressed Treasury yields in the past few years, which caused a flood of capital into equities. In this environment, there was simply see no need to hedge for risk. The Federal Reserve, it seems, made hedge funds obsolete.
2013 was also a great year for speculators and traders, as long as they stayed long. Even bubble stocks (TSLA, DDD, KNDI, IBB, P) saw explosive growth during the hot money days. Like the indexers, these gamblers saw no need to manage risk and no reason to be careful. While the indexers have not yet had a rude wake-up call, the speculators have. Those speculative bets are massively underperforming now, and “buying the dip” no longer works in stock selection. Already, the thrill of high-risk betting on 3D stocks and other trendy new industries has worn off for many.
For 2015, a major correction or increased volatility will make many indexers pause about their aversion to active strategies. A growing divergence between indexes, and a strong alpha delivery from a pocket of the hedge fund or mutual fund world would help. While there is no guarantee that this will happen—currently, the S&P 500 looks healthier than any other market around—there are hints of a divergence leading to better active investing performance. SPY, DIA, and IWM are not rising anywhere near the same level, and their returns are no longer risk-adjusted. Meanwhile, QQQ beat them all. More divergence and higher volatility could make passive investors reconsider their approach, and that is the key to look for in 2015.