It is always dangerous to make predictions, especially for an entire year.  However, reasoned judgments should be considered for their potential impact on investments.  Here are our general thoughts going into the New Year:

1)   Vladimir Putin will not sit idly by as falling energy prices put pressure on the Russian economy.  He currently has the support of the populace.  That support will fade though if the economy worsens.  Expect some geopolitical surprise from Russia as Putin tries to divert attention away from the economy.

2)   The quiet in Washington will be replaced with more rancor and headlines.  Now that Harry Reid is no longer in control of the Senate, bills will pass that Obama will veto.  Let the games begin.

3)   Europe and Japan will continue their policies of currency devaluation as a means to spark economic growth.  The big surprise in 2015 may be that China will join them in devaluation.  Why? As European and Japanese goods become cheaper, China will be impacted and will devalue its currency to compete.

4)   The Federal Reserve will raise rates in 2015.  If the stock market reacts negatively, it might be a one and done increase.   If the market’s move is worse than anticipated, don’t be surprised to see another round of quantitative easing.  This could happen because the newest members of the Federal Reserve are more dovish than the hawkish members they replaced.  If markets don’t falter, expect a gradual increase in rates throughout the year.

5)   More headlines about Europe in crisis will appear.   Stories of continued economic malaise, the “Greek Tragedy”, anti-immigration and Catalonia breaking away from Spain will likely fill the headlines.  The ECB has brought about three years of calm, but that calm will not last as European frustrations may boil over this year.

Thoughts on the Markets and the Economy:

1)   The markets will revert to the mean and there will be a shift as international, emerging markets and small company stocks outperform US large companies.

2)   Inflation will start to rise as wages start to rise.

3)   Profit margins of large US companies will be under pressure from the rising dollar and a shift from the “wind at their backs” which has occurred over the past few years in lower employee costs, lower interest rates and lower tax rates to suddenly becoming headwinds.

4)   Volatility in the stock market will increase this year.

5)   There will be headline risk on the corporate bond side.  One of the side effects of the Frank–Dodd bill is that banks no longer offer the needed liquidity in the bond market as they have in the past.  No one knows with certainty how that lack of liquidity will impact the bond market if the Federal Reserve starts raising rates.

Book of the Month – The Forgotten Depression – 1921: The Crash That Cured Itself – James Grant

This is a book written by one of the top economists in the world – James Grant.    Grant is widely known for his newsletter “Grant’s Interest Rate Observer” which for many is considered the Bible for understanding the direction of interest rates.   Jim tells the story of the last Depression that solved itself before the Federal Reserve and government intervention became popular to solve economic problems.  It describes a horrible economic environment that lasted about eighteen months, but self- corrected.  In other words, prices fell to a point where demand picked up and the economy started to move forward.  For example, light truck sales in the US are up over the past two months as gas prices have fallen.  In 2008, when oil was over $150 a barrel, no one was in the market to buy a light truck.  The most interesting part of the book is that it seemed that people understood that corrections are normal and part of the business cycle.  The mood of the people today is different in that they seem to expect more government intervention during economic turbulence rather than less.  Government intervention, however, can sometimes prolong the pain of needed adjustments.

Hope everyone had a joyous and safe Holiday Season.

Sincerely,

Your THOR Team