2014 was a year of divergence in the global economy: US economic growth accelerated, while growth in many other countries slowed or (especially in Europe) remained stagnant. Largely as a result of this trend, the US dollar increased in value against the world’s other major currencies. The implication for financial markets was a good year for US stocks and US bonds, a weak year for international stocks and international bonds, and a terrible year for commodities.
The top-performing sectors of the stock market were utilities, health care, communications, and consumer staples. These sectors are typically considered “defensive” sectors, meaning they often outperform the broader market when the economy is weak and underperform when the economy is strong. That fact may seem odd considering the signs—such as strong GDP growth and a declining unemployment rate—that the US economy is strengthening. But these are also sectors that tend to offer higher dividend yields, which make them particularly attractive to some investors in the current low-interest-rate environment. Since interest rates are likely to start rising in 2015, these sectors may not be able to continue their outperformance for much longer.
At the other end of the spectrum, energy was the only sector to post a negative return. Energy stocks suffered from the decline in commodity prices. Oil companies in particular were hurt as slowing economic growth in places such as China and increased production using methods such as hydraulic fracturing (or “fracking”) caused the oil price to halve in 2014.
The top-performing countries were all Asian countries bouncing back from weak stock-market performances the previous year. The most notable of the group, India, saw a stock market surge as it recovered from an economic swoon in the middle of 2013 and as Narendra Modi’s Bharatiya Janata Party swept to power in elections in May.
The worst-performing countries were smitten with political turmoil. Russia’s military adventurism in Ukraine led to international sanctions, which combined with the plunging oil price devastated Russia’s energy companies and banks and caused the country’s currency, the ruble, to decline in value. In Greece, the rise of a radical anti-Europe Syriza party has led to speculation that the country could leave the euro zone in 2015.
The ups and downs of financial markets in 2015 will likely be driven by a few key factors. Whether the global economy remains weak while the US economy surges ahead, and therefore whether the US dollar continues to gain value relative to other currencies, will affect the performance of essentially every asset class. How the Federal Reserve manages the US economy—can they begin to raise interest rates without slamming the brakes on economic growth?—will determine whether the winning streaks for US stocks and US bonds continue.
Whether the oil prices rebounds will affect not just commodities as an asset class, but also the energy sector and countries such as Russia that rely heavily on energy production. And political risk is likely to once again be an important factor in 2015, not just in small emerging markets but in Europe as well.