2014 Recap: US Investments Shine While Commodities Lag

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.

2014 Asset Classes

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.

2014 Stock Sectors

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.

2014 Countries

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.

Q3 Recap: US Dollar Rises as Political Risk Predominates

The third quarter of 2014 was full of geopolitical turmoil: Russia’s proxy war with Ukraine, renewed US military involvement in the Middle East, and Scotland’s independence referendum were among the notable events that took place. In the investment world, this mayhem translated into weak stock markets and a rising US dollar relative to most other currencies.

The rising value of the dollar contributed to a terrible performance for commodities, which had their worst quarter since the global financial crisis in 2008, and losses for both stocks and bonds outside the US. The only asset classes that eked out slightly positive returns in the quarter were US investment grade bonds and cash.

Q32014 Asset Classes

The energy sector was the worst-performing stock sector as falling commodity prices hurt energy companies. The sector’s plunge makes energy one of the worst-performing sectors year-to-date; the health care sector, which continued to post solid returns in the most recent quarter, is now the top-performing sector so far this year.

Q32014 Stock Sectors

Stocks in every developed country outside of the US took a beating. Some of the smaller European countries such as Austria and Greece fared worst, but Australia, Germany, Italy, and Spain were among the other countries that had worse than -8% returns for the quarter.

Q32014 Countries

Political risk will likely continue to play a key role in financial markets going forward: additional political instability could cause the trends from the third quarter to continue. Much will also depend on the actions of the Federal Reserve in the US and the European Central Bank in Europe, which are moving their policies in opposite directions. The Fed is winding down its “quantitative easing” program that was aimed at boosting the economy and is now talking about raising interest rates next year, while the ECB is desperately trying to foster faster economic growth. If the ECB succeeds, European stocks could reverse the shellacking they experienced this past quarter.

Q1 Recap: US Stocks Overcome Russia, China to Stay in Positive Territory

The first quarter of 2014 had a few bumps in store for financial markets, yet in the end almost every asset class ended up with positive returns. Bonds performed well as interest rates declined and the US inflation rate remained below the Federal Reserve’s 2% target. US stocks recovered from January jitters to end the quarter in positive territory. Even emerging market stocks, buffeted by fears of financial instability in countries such as Turkey, Russia’s military adventurism in Ukraine, and weak economic data from China, finished the quarter only slightly down.

Q12014 Asset Classes

Despite the continued US stock market gains in the first quarter, the economic optimism that fueled last year’s stock market surge showed signs of fading. Weak housing market data helped more defensive sectors such a utilities and health care outperform the broader market.

Q12014 Stock Sectors

The Russian stock market was pummeled in the first quarter as fears mounted that the country’s annexation of Crimea would crimp its economy and its ability to export natural resources. Russia’s troubles may have obscured a more important development, however: disappointing economic data in Japan and China led to a weak first quarter for Asian stocks.

Q12014 Countries

The outlook for the Chinese economy is likely to be one of the key drivers of financial markets for the rest of 2014. For years bearish analysts have been predicting a financial crisis in the world’s second-largest economy, and declining property prices in China could be the start of a broader collapse that finally validates these gloomy prognostications.

Yet so far the Chinese government has overseen a fairly orderly decline in the country’s economic growth rate, and it has the capacity to stimulate the economy if it fears that trouble in the real estate market is spreading. Success in containing the fallout from the economy’s slowing growth would provide a boost for stocks around the world, particularly in China itself where valuations are very low compared to other countries.