Opportunities and risks for investors in 2015

Dana R. Consler, The Daily Record Newswire

The U.S. stock market delivered once again in 2014 with its sixth year in a row of positive returns, the best stretch since the 1990s. Stock prices have been driven upward by a strengthening economy, rising corporate earnings and continued easy money courtesy of the Federal Reserve. Several mini corrections brought new money into the market leading to quick recoveries.

Foreign stock markets suffered low single digit negative returns for myriad reasons, including the strong dollar, anemic or negative economic growth in many countries and endless geopolitical turmoil. Instead of shunning international markets, investors need to add more exposure.

The bond market surprised most investors by returning about 6 percent for taxable bonds and more than 8 percent for tax free municipal bonds. Remember reading: "Avoid the bond market because interest rates are going up this year?" Turns out interest rates actually went down in 2014, as we predicted they would, and the bond market produced excellent returns well ahead of inflation. Returns from CDs and money funds continued at more or less zero as the Fed kept interest rates extraordinarily low for yet another year.

Going forward here is what we see for investors in 2015, both the opportunities and risks:

- The economy will accelerate to a 2.75 percent to 3 percent real annual growth rate, up from the 2.25 percent trend during this six-year recovery. Unemployment will drop further but the uncertainty is whether wages and incomes will increase enough to produce worrisome inflation. We don't think it will. So the low inflation, low interest rate scenario will likely underpin the economy, at least for the first half of the year.

- Stock market volatility should increase over 2014 as the bull market extends at least another year. The bull market's seventh year begins in March with valuations considerably higher than any time in the last three years.

- Corporate earnings should power ahead by 6 percent to 7 percent. Low inflation and improving economic conditions and consumer sentiment will help as well. Lower gas prices are estimated to save $80 billion in 2015, putting more money in consumers' pockets to spend.

- U.S. stocks should move higher by 4 percent to 8 percent but with increased volatility compared to recent years. Low interest rate levels make alternatives to stocks, like cash and bonds, far less attractive in the minds of many investors.

- The Fed is projected to begin raising the overnight Fed funds rate in the second half of the year. This will happen in very small steps of ¼ percent at a time. Estimates are for that key rate to only have moved up to 1.25 percent or so by year end. Rates may not increase until the Fed sees a combination of inflation running at a 2 percent annual rate and wages and incomes growth of 3 percent or more.

- Historically, back into the late 1950s, rising interest rates have rarely hurt the stock market. It isn't until the Fed completes the process of raising rates to their target, which could take several years, that stocks will begin to suffer.

- Foreign stock markets look increasingly attractive based on much lower valuation levels than here at home. Europe and Japan are especially cheap and are likely to benefit from monetary stimulus in 2015, whereas here stimulus is being reduced. Emerging markets have been battered in recent years but are also cheaply priced. We recommend a prudently diversified equity portfolio should include 25 percent to 35 percent in non-US stocks and, of that, about 15 percent should be invested in emerging markets.

- Beware advice to buy dividend heavy stocks as an alternative to bonds in this low interest rate environment. When a bear market reappears, you'll likely suffer a bigger loss to your portfolio than if you had stayed in a conservative, high quality, intermediate duration bond portfolio.

- We are closer to the top of the multi-year stock market cycle than to the bottom. How you navigate the next few years will be critical to weathering the next bear market when it comes. Consider alternative investments in 2015, which will also reduce risk compared to stocks. These are strategies that don't correlate closely with either stocks or bonds.

- Now is an excellent time to rebalance your portfolio to reduce risk. A 60 percent stocks-40 percent bonds asset mix could, over the last three years, have moved your portfolio to close to 70 percent stocks now, and to almost 80 percent if you were at 70 percent-30 percent to start. Now that you're three years older, perhaps nearing retirement, you need to reduce risk. Rebalance back to your target allocation.

Investors tend to project the strong investment returns of the recent past forward indefinitely, but that's unwise. What is realistic for 2015 is stock returns that are mid-to-high single digits and bond returns that are low single digits, each with increasing volatility and uncertainty. Make it your resolution to be well-diversified and allocated to the level of stock and bond exposure that fits your age and tolerance for risk.

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Dana Consler is executive vice president of Karpus Investment Management, a local independent, SEC-registered investment advisor managing over $2.4 billion of assets for individuals, corporations, nonprofits, retirement plans, IRAs, unions and trustees. Offices are located at 183 Sully's Trail, Pittsford, NY 14534; phone (585) 586-4680 or email dana@karpus.com.

Published: Mon, Jan 12, 2015