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These are the charts and themes that tell the story of 2014.
The Fed Funds Target Rate was held at 0% for a sixth consecutive year, an unprecedented period of easing. Still, the Federal Reserve remained dovish, promising to be “patient” for a “considerable time” before raising interest rates.
Not to be outdone, the ECB moved to negative interest rates in June and the Bank of Japan announced further increase in quantitative easing in October.
This easy money backdrop – more than any other factor – was the dominate narrative in 2014. Any and all “bad news” (recession in Japan, slowing Europe, Ruble collapsing, etc.) were deemed irrelevant. As long as the Fed is targeting another bubble, it was said, perhaps nothing else matters.
Coming into the year, the universal expectation among economists and strategists was for a “rising rate environment.” The exact opposite occurred, with yields in developed nations across the globe moving sharply lower throughout 2014. In fact, we saw new all-time yield lows in Germany, France, Italy, Spain, and Japan. In the U.S., the 10-year Treasury yield fell from 3.02% to 2.17%. Strategists were predicting the 10-year yield to end the year at 3.40%.
In the exact opposite of 2013, the yield curve flattened throughout the year.
Yields were falling, and along with them, growth and inflation expectations which hit their lowest levels since 2010.
Historically, a precipitous fall in yields accompanied by falling inflation expectations was viewed as a negative for markets. In 2014, this relationship was flipped on its head. This time, the prospect of slower global growth bringing about more central bank stimulus was the more dominant theme. Under the new regime, slower (Europe) and even negative growth (Japan) was to be viewed favorably. As such, we saw a growing disconnect in 2014 between stock markets and economies.
In the back half of the year, strength in the dollar (and weakness in Crude and other commodities) became a major theme.
The Dollar Index reached its highest level since early 2006 and perception of dollar strength was changing. In recent years (2008, 2010), persistent dollar strength was viewed negatively as a risk-off signal, a flight to safety. In 2014, more similar to the late 1990’s, dollar strength was viewed favorably.
The rationale behind this view was threefold. First, the Dollar Index is heavily weighted towards the Euro and the Yen. With both the ECB and BOJ seeking to depreciate their currencies via monetary easing, dollar strength against the Euro and Yen was an affirmation that central bank policy was indeed working. It seems counterintuitive, but a crashing Yen and Euro was now thought to be bullish for all.
The key shift for Europe came in June with the announcement of negative interest rate policy. From that point forward, Europe became Japan, with European stocks taking their cue from the currency markets.
A second viewpoint developing was that Dollar strength signified that the U.S. was successfully decoupling from the rest of the world. While the rest of the world was slowing, it was said, U.S. growth was accelerating.
This narrative was primarily derived from recent stock market history which showed U.S. equities far outpacing their global peers.
The actual data was less supportive of this view, still showing the current U.S. recovery (in terms of real GDP growth and real wage growth) to be the slowest in history.
A third factor behind the “bullish dollar” thesis was the opposite effect it had on commodity prices, particularly Crude Oil. The price of Crude was cut in half from its June high in one of the sharpest declines in history.
Unlike the prior move lower in 2008, the U.S. was not in a recession this time and the resulting drop in Gas prices (from $3.69 in April to $2.27) was deemed to be a “free” lunch to U.S. consumers.
The historic decline in Crude created an environment of winners and losers. On the winning side, there was no bigger beneficiary than the Airlines which advanced over 47%.
Within Emerging Markets, the divide was glaring. Net consumers of Crude (China, India) advanced while net producers (Brazil, Russia) declined.
The gift of lower oil to U.S. consumers was anything but for mother Russia. By mid-December, the Ruble had lost over half of its value against the U.S. dollar and Russia was forced to hike interest rates to 17% in an effort to prevent a currency collapse.
The U.S. equity markets largely ignored the issues in Russia in 2014 as investors viewed its impact as limited, particularly in light of continued Fed stimulus.
The dominant theme was still that the U.S. was in a “Goldilocks” period of low inflation and unprecedented central bank action. As such, the ratio of commodities to U.S. stocks plummeted to record lows. The “secular bull” in commodities that was said to have begun around 2000 was officially over.
The untold story in 2014 was the defensive backdrop within U.S. markets, with Utilities and Long-Term Treasuries far outpacing the equity indices. The top two sectors (Utilities, Health Care), both defensive, was in the past associated with periods of slower growth and market stress (1990, 2000, 2008, and 2011). In 2014, this defensive behavior was in large part ignored, a historical anomaly.
Within the Credit Markets, we also saw increased risk aversion, with credit spreads widening (from 400 bps to 498 bps in US high yield) and high yield bonds and leveraged loans underperforming safer issues.
The broad stock averages ignored this underlying weakness but the risk/reward was clearly changing. Investors were no longer being paid for taking on the risk of higher beta.
If I had to pick one chart that summed up 2014 in the U.S. equity markets it would be the same as 2013: The V-bottom formation. The longest streak above the 200-day moving average in history ended in October, but the v-bottom and “buy the dip” mentality did not end with it. Since the beginning of 2013, all minor dips have been followed by straight up moves to new highs.
These were the key charts and themes of 2014. As always, the narrative followed price. As prices change in 2015, the narrative will change with it.
Most of these themes were surprising if not shocking to many. How many could have predicted at the start of the year that we would see a 50% drop in Crude, a 50% fall in the Ruble, and a Spanish 10-year yield well below that of the U.S. 10-year?
In 2015, I predict one thing: you will see many more surprises. That is the nature of markets.
Thank you for your readership in 2014.
Wishing you all a happy, healthy and prosperous New Year.
This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of two award-winning research papers in 2014 on Intermarket Analysis and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors, an institutional investment research firm. Previously, Mr. Bilello held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms, giving him unique insights into portfolio construction and asset allocation.
Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.
You can follow Charlie on twitter here.
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