The U.S. in 2015: A Cautiously Optimistic Recovery

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Economic conditions in the U.S. have clearly improved since the dark days of the Great Recession. The economy grew nicely in 2014, unemployment fell, home prices rose and stocks racked up another fine year. Even bonds did well, surprisingly.

But can it continue?

Though there are indeed some concerns, such as the strong dollar’s effect on exports, Wharton finance professor Jeremy Siegel and Mark Zandi, chief economist at Moody’s Analytics, say the odds favor additional good news in 2015, though economic and market performance may not match last year’s.

Gross domestic product could grow by about 3% this year — not as hot as the 5% in the third quarter of 2014, but still respectable, Siegel says. (Year-end results are not yet in.) Low interest rates and low oil prices will boost the economy, he notes. “People will have more money to spend.”

“It should be a good year, particularly for the economy and for jobs,” Twitter  Zandi adds. “We created three million jobs last year. We’ll create about the same amount this year. We should be at full employment by early 2016.”

Interest rates may rise slightly but should remain low by historical standards, says Siegel, who predicts lower than average rates “for many years to come.” He notes that the Federal Reserve may raise the Fed funds rate to a still-low 1.5% to 2% from the current target of 0 to 0.25%. Bond yields, which fell in 2014, largely because of high demand from investors seeking safe havens amidst international turmoil, will remain low, keeping mortgage rates down as well, Siegel adds.

“We should be at full employment by early 2016.”–Mark Zandi

That will help the housing market continue to recover. “There’s a lot of housing in GDP,” Siegel says, noting home construction’s effect on sales of appliances, furnishings and other products. “Housing is definitely important.” Various studies have suggested home prices could rise by 4% to 6% this year. Those figures would beat the long-term average of around 3%, but be comfortably short of a bubble. Price gains have been slowing after the big rebound following the financial crisis, and many experts think today’s closer-to-normal gains are healthier.

Full Employment on the Horizon?

The number of home sales has been disappointing for years, Zandi says, but he, too, expects factors that have dragged on the market to “begin to fade.”

Among those factors: unemployment and poor wage growth. Unemployment, which peaked at 10% in October of 2009, fell to 5.6% in December and should continue to decline, Zandi notes. “If we’re close to full employment by this time next year, then wage growth will accelerate.” Siegel adds that the falling unemployment rate has not yet brought back into the labor force many of the people who gave up looking for work in recent years. If those workers stay on the sidelines, he cautions, lower unemployment could cause wages to rise fast enough to trigger concerns about inflation. That said, neither Siegel nor Zandi expect inflation to become a problem in 2015.

Both note that falling oil prices are likely to hurt oil producers, but they say the country overall will benefit from low energy prices. “Clearly, the collapse in oil price is good for the economy,” Siegel notes. “All this could be very good on the cost side, and that could boost corporate profits for the next year.”

The strong dollar will continue to keep down the cost of imported goods, but will cut into profits of U.S. companies doing business abroad, Siegel and Zandi say. “The biggest weight on growth will be trade,” Zandi explains, “in part because of the surge in the dollar and in part because of the weaker global economy.”

“Clearly, the collapse in oil price is good for the economy. All this could be very good on the cost side, and that could boost corporate profits for the next year.”–Jeremy Siegel

U.S. stocks had a good run in 2014, with the Standard & Poor’s 500 returning about 13.7% with dividends reinvested, following a stupendous 32.4% the year before. Surprisingly, the 10-year U.S. Treasury note returned about 11% as falling yields pushed up prices. Most experts had expected yields to rise in 2014, not fall.

Taking Stock of Stocks

What’s in store for securities this year?

“Obviously, we’re closer to fair market value on stocks than we’ve been anytime in the last five years,” Siegel says. Being closer to fair value, a measure of share prices relative to corporate profits, makes big gains harder to come by, he observes. But he adds that low interest rates improve the picture because investors are more willing to take on the risks of stocks when they don’t earn much in bank savings or bonds.

The average S&P 500 stock is currently priced at about 19 times the company’s earnings for the past 12 months. While that’s a high price compared to the long-term average of around 15 times earnings, it is far below the 30-to-1 level of the last great stock bubble 15 years ago. Siegel says a price-to-earnings ratio, or PE, in the high teens can be considered fair value when interest rates are as low as they are today. “Given the interest rates, the stock market is still undervalued,” he says, forecasting an S&P 500 return of 10% to 12% for 2015. Zandi is a bit more conservative, forecasting stock gains in the mid-single digits.

“But it could be rocky,” Zandi adds, observing that the strong dollar will likely undercut earnings.

U.S. investors, Zandi says, might be wise to look at European stocks, as PEs are lower there than in the U.S., and because the strong dollar makes foreign stocks cheaper for investors using dollars.

For 2014, the 10-year Treasury note returned just over 11% as falling yields pushed prices up. But neither Siegel nor Zandi expect bonds to do as well this year, because yields have already fallen so low — a scant 1.8% for the 10-year Treasury. Zandi expects interest earnings to be wiped out by falling bond prices as yields inch up. “This year,” Siegel adds, “bonds are much riskier because interest rates are almost at an all-time low.”

For long-term investors, Siegel says, stocks remain the most promising bet, likely to produce better returns than bonds or cash for investors who can wait out the downturns.

“Obviously, we’re closer to fair market value on stocks than we’ve been anytime in the last five years.”— Jeremy Siegel

What could darken this generally rosy picture? The unexpected is, of course, is unpredictable, but Zandi and Siegel both cite worries about terrorist acts or a shock like last year’s Ebola outbreak.

Zandi adds that it is very difficult to know how the financial markets will react if the Fed does start to raise interest rates, even if only modestly. Uncertainty as rates rise often causes volatility to increase in the stock, bond and currency markets, he warns.

Economic problems in Europe and Asia could send shudders through the U.S. economy and financial markets. And there are many crises that could blow up in the Middle East and elsewhere.

“There are a lot of geopolitical hotspots that could boil over and have implications for [the U.S.] economy,” Zandi notes. “The black swans are more likely to come from overseas than from within our own borders.”

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