Thoughts on where to focus in 2015

Arguably, U.S. investors have reason to be optimistic entering 2015. After all, by the end of 2014,

• domestic stocks (represented by the Russell 3000^® Index) had just delivered a six-year bull market
• the U.S. economy and job market had improvement
• the U.S. Dollar had strengthened significantly relative to other major currencies – making the rest of the world appear on-sale for U.S. Dollar-based investors.

However, there are a few potential dampeners to that enthusiasm:

• diverging central bank policies, as economies outside the U.S. continue to attempt to regain their footing through implementation of QE-style stimulus packages
• potential capital market and geopolitical implications of the plummeting price of oil
• and of course, the ever-present risk of unpredictable geopolitical wildcards such as the Crimeas and Syrias of this world.

On the one hand, these dynamics can be interpreted as instigators of uncertainty – and hence volatility – in capital markets. At Russell, our view is that these dynamics will present investors with markets in 2015 that are likely to experience an volatile ride, but yield an ordinary outcome. We believe that long-term, disciplined investors should expect volatile markets – but also average investment returns for a hypothetical 60% equity / 40% fixed income portfolio. Let’s dig deeper into some of the factors that we believe will drive markets in 2015 – and how you might want to consider positioning client conversations – and portfolios – accordingly. Divergent Central Bank policies: Russell expects the U.S. Federal Reserve will start raising the Federal Funds Rate in mid-2015 against a favorable domestic economic backdrop. We forecast U.S. GDP growth of 3.0% for the year, core inflation growth of 2.0% and non-farm payrolls numbers to come in at over 200,000 jobs per month on average. Central Bank policies outside the U.S. are likely to look different – and many already do. Where economic growth has been less robust, many central banks are moving in the opposite direction of the U.S. Federal Reserve. Namely, they are easing monetary policy, rather than tightening it. For example,

• on January 21^st, the Bank of Canada made a surprising quarter of a percent interest rate cut
• on January 22^nd, the European Central Bank announced that it will begin a quantitative easing program in March
• expectations are for the Bank of Japan to continue its existing easing program in 2015
• it’s possible that the Bank of China may start a program, too

As previously discussed on this blog, such passing of the quantitative easing baton can create instability – particularly if coupled with unforecastable macro events. But, they can often also offer opportunities for diversified investors who are able to take advantage of indiscriminate selling (and hence depressed prices) of otherwise attractive investment opportunities. Falling price of oil: Speaking of sources of potential unforecastable macro events – one of 2014’s biggest stories that has carried over into 2015 is the precipitous fall in oil prices: in June 2014, Brent oil was priced at $115 a barrel. Today it is trading below $50. Overall, we believe that this development is a net positive for the global economy – particularly for net oil importers (e.g., the U.S. and Eurozone). However, it does pose some potential risks at the geopolitical level (e.g., pitting net oil importers against net oil exporters; creating instability in countries that are net oil exporters, etc.) and at the capital markets level, particularly given the magnitude and speed of the price decrease. Potential implications for capital markets Within equites, the energy sector was the most immediate and obvious victim of soft oil prices. While the Russell 3000^® Index finished 2014 with a 12.6% return for the year, the energy sector was the only sector with a negative return for the year – ending the year down by -10.2%. It will take time to identify which other sectors might be negatively impacted by the oil price. In the meantime, this uncertainty may spur market volatility. Within fixed income markets, our biggest watch point is U.S. high yield bonds – approximately 15% of which are energy sector issues, (based on the Bank of America Merrill Lynch U.S. High Yield Index as of December 31, 2014). . Finally, since oil is priced in U.S. Dollars, its price is likely to influence currency movements globally. Portfolio considerations So how might you want to consider positioning client portfolios in 2015? Within a well-diversified, multi-asset portfolio consisting of stocks, bonds and real assets exposures, we currently have a preference for equity relative to fixed income.

• Within equities, Europe may offer more attractive opportunities than Japan and the United States in our models
• Within credit, we believe investors will be better rewarded for credit positions than for investments in Treasuries

Of course, it goes without saying that the most important consideration is that the portfolio be one that has the potential to meet the investor’s long-term goals – and yet is one that the investor can stick with through potentially choppy markets in 2015 and beyond.