Given the strong U.S. economic results relative to overseas counterparts during the past year, it was not surprising that 2014 investment returns in the U.S. dominated other global markets. With the health of the domestic economy improving, the Federal Reserve stopped quantitative easing in October and shifted toward raising U.S. interest rates. Meanwhile, their counterparts overseas have new easing programs under way, leading many financial experts to say that the U.S. has “decoupled,” or separated, from the rest of the world. We prefer the term “diverging,” defined as moving in different directions but still linked. Increasing divergence is the overriding theme of our 2015 outlook.
U.S. markets outperformed other markets in 2014 due in part to diverging fundamental, technical and economic policy differences. The divergence was most apparent in the equity market, where the S&P 500 returned double digits for the year, while both the MSCI EAFE Index and MSCI Emerging Markets Index declined. This divergence was exacerbated by the surging dollar, which flipped gains in local currency terms to losses when measured in U.S. dollars.
Similar success was seen in other areas as well. U.S. fixed income generally enjoyed higher returns than bonds in other developed countries. The standout performer for 2014 in the asset classes we follow was U.S. real estate investment trusts (REITs), which were up 30% for the year.
For 2015, we expect the positive momentum for the U.S. economy to continue. However, believing our economy can operate independent of the rest of the world is somewhat simplistic and risky. We are connected to the overseas economies in many ways, but explicitly through the financial markets and commodity markets. The following are some examples of that interconnectivity:
- One reason U.S. interest rates are low is that our intermediate and long-term bond yields are more attractive than Japanese and German fixed income instruments on a relative basis. So when the Federal Reserve ended its quantitative easing, demand from U.S. and global institutional and retail investors took up the slack.
- The dollar is strong not only because our economy is growing, but also because Japan and the eurozone are further reducing their interest rates through monetary programs, driving global demand for dollars.
- Our stock market is benefiting from our better relative fundamentals as overseas investors choose to invest here rather than in other parts of the world. The U.S. equity market is reflecting this in its higher valuation relative to other markets and its own historical valuations.
- U.S. oil production is a big reason why global oil prices have declined. Lower energy prices have positive implications for U.S. consumers, but other countries benefit as well. Because the vast majority of Asia imports its energy, lower prices should boost their economies.
Last year, the United States was the dominant player within the global economy, and we expect more of the same in 2015. We favor U.S. equities over international equities and U.S. fixed income over our global counterparts but would hold international investments given stimulative monetary policy overseas. We are being very selective in choosing assets tied to energy as the shifting structure of the oil market will create distinct winners and losers. Fed policy changes are coming, and while the Fed has tried to hint at its thinking on the interest rate changes, rates will be changing direction for the first time since 2008. Change is often accompanied by greater volatility. With this in mind, we recommend reviewing your financial objectives and taking the time to connect with your advisor to make sure your portfolio is positioned appropriately.