Market Perspective January 3, 2015

Investors took their profits on the last day of trading in 2014, putting stocks on course for a weekly loss. Small caps, which lagged in 2014, performed the best during the week. Leading sectors such as utilities suffered some of the largest losses. The loss wasn’t enough to cost utilities its crown as the best performing sector in 2014 though. It finished the year up 27.29 percent (including dividends) according to Morningstar, ahead of the 25.89 percent rally in healthcare.

Real estate advanced 28.68 percent in 2014, helped by the low interest rates that also benefited the utilities sector. Among subsectors, semiconductor memory manufacturers fared the best, with a 62.09 percent return according to Morningstar. Falling oil prices and a strong domestic economy was good news for the airline industry: airlines gained 58.31 percent last year. Specialty drug makers, which includes biotechnology firms, rallied 42.42 percent. The worst performing industries in 2014 were commodity related. Oil & gas drilling companies fell 46.11 percent. Many oil producers will continue pumping oil at lower prices, but they will stop drilling new wells. Industrial metals & minerals lost 28.48 percent, hurt by the collapse of iron ore prices as China’s economy slowed. Steel slumped 27.38 percent.

Value funds beat growth last year, and large caps beat mid and small caps. Large Blend was the best Morningstar category, up 10.96 percent. Small cap growth was the worst, up 2.44 percent.

Globally, the best performance came from China and India. Most investors didn’t participate in China’s 53 percent rally because A-shares were hard for foreigners to buy until November of this year. Chinese  funds were middling in their performance, finishing with small positive gains thanks to the yuan and Hong Kong dollar’s tight relationship with the U.S. dollar, which prevented large currency losses. Investors did have access to India though, which rallied 45 percent. Most of those gains came early in the year when investors poured into India ahead of, and just after, the election of pro-business Prime Minister Narendra Modi.  Most foreign funds were down for the year, pulled lower by currency losses. European equities gained on the year when priced in euros, but due to the double-digit loss in the euro, most funds fell in 2014. The worst performing international category was Latin America. It fell 12.90 percent, hurt by weak commodity prices and weaker currencies.

Among bond funds, long-term government bonds were the winner. Morningstar’s category climbed 21.69 percent. iShares Barclays 20+ Year Treasury (TLT) gained 27.31 percent in 2014. The worst performing bonds were emerging markets, but their loss of 0.82 percent on the year was quite small considering the category lost 4.03 percent in December alone. High yield municipal bonds led the muni category with a 13.84 percent gain.

In economic data this week, the December purchasing managers’ indexes from Markit and the Institute for Supply Management came out on Friday, and both dropped. While they both still show a solid manufacturing expansion, many energy companies are canceling projects due to low oil prices. China’s PMI dipped below 50, signaling contraction, and that weighed on commodity prices in Friday trading.

Turning to 2015, the outlook is bright for U.S. markets. The economic recovery is picking up speed, the dollar is strong and the Federal Reserve is biased towards hiking interest rates. Trouble for Japan, Europe, Russia and China aren’t good news for the U.S., but relatively speaking, the U.S. looks far more attractive as an investment. Problems that emerged in 2014 are likely to continue in 2015, in different form. Russia will have to deal with  the fallout from lower oil prices, as will U.S. states that relied on shale oil production for economic growth in recent years. Even if oil prices stabilize, local real estate and other tertiary industries may be impacted negatively in 2015. In Europe, sovereign debt may take center stage again should Greece elect an anti-austerity government at the end of this month. Assessing the global picture, many investors are likely to park more of their capital in U.S. investments, either to benefit from stronger returns or simply to avoid trouble. Yesterday, German government 5-year bond yields declined to negative 0.1 percent. For investors looking to avoid trouble in Europe, the 1.65 percent yield on 5-year U.S. treasuries looks far more enticing.



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