Bottom Line Economic Forecast 2015 from Allen Sinai, PhD

Can the US stock market continue to shine when much of the global economic outlook is gloomy? That’s the crucial question we posed to top economist Allen Sinai, who twice a year forecasts for Bottom Line/Personal readers what’s ahead for the economy and markets.

Here is Sinai’s response…what he sees ahead for 2015…and how it will affect you and your investments…

Two Surprising Developments

The US economy and markets will remain healthy in 2015, although investors need to be prepared for greater volatility. That’s largely because two surprising developments are strengthening the US economy and will continue to do so. As a result of those developments, along with continuing huge technology-driven gains in productivity, I expect the Standard & Poor’s stock index to gain 13% in 2015 and unemployment to end the year at 5.1% (down from 5.8% in October 2014). The US economy will continue to expand at least through 2017.

Surprise #1: Oil prices have plunged by 25%, resulting in much lower ¬prices for gasoline and other forms of energy. As a result, many businesses, including transportation companies, farms and manufacturers, will see better profit margins as their costs fall. Lower energy prices also give consumers more money to spend on discretionary items such as restaurant meals and travel. For every one-cent drop in the price of a gallon of gasoline, US consumers save about $1 billion per year.

Surprise #2: Inflation has remained much tamer than expected. This has helped keep long-term interest rates —including mortgage rates—low, benefiting consumer and business borrowers. It also will allow the Federal Reserve to raise short-term interest rates very slowly for years, keeping them below their historical averages.

Despite these helpful catalysts, several challenges will roil the US stock market in 2015, creating greater volatility…

The shaky global economy. Economic growth for the European Union is forecast at a paltry 1% in 2015…Japan is expected to grow just 1.2% in 2015…and China’s growth likely will be 7.1%, down from an estimated 7.3% in 2014 and much lower than the blistering 10.4% pace in 2010.

My assessment: The US economy can continue to show steady, solid growth even if there is meager growth around the world or a recession in Europe. Exports to Europe account for just about 20% of US foreign trade. And our overall exports account for just 14% of total US gross domestic product. It would take a severe global recession to hurt US prospects at this point. That’s unlikely to happen because foreign central banks still have extensive stimulus measures at their disposal if their economies start to nosedive.

Rising short-term interest rates: I expect the US economy to be strong enough by June 2015 to prompt the Federal Reserve to start raising interest rates for the first time in seven years. Anticipation of higher rates will lead to lots of stock market ups and downs as investors worry that the higher rates will put a brake on economic growth.

My assessment: As inflation remains low, the Fed will raise rates slowly and steadily enough to avoid hurting the economy and corporate earnings or choking off corporate borrowing.

Geopolitical wild cards: Conflicts in several parts of the world could shake up markets. Among them, tensions between Russia and the West could grow over Russia’s actions in Ukraine and other issues. And actions by extremists could cause the US to continue increasing its military intervention in Iraq and Syria, pushing up defense spending.

My assessment: Both these threats seem containable. In Russia, the collapse in oil prices, coupled with Western sanctions, is hurting the Russian economy so much that Russian president Vladimir Putin’s actions will continue to be limited. And US involvement in the Middle East won’t escalate to the point where markets fear a major impact on oil prices.

Key Economic Measures

Here’s what I expect for 2015…

Gross domestic product (GDP): This measure of the nation’s economic output likely will rise 3.3% for 2015, as consumer and business spending strengthen.

Inflation: With low energy prices, the Consumer Price Index (CPI) should rise just 1.5% in 2015, similar to the estimated inflation rate for 2014 and short of the Federal Reserve’s inflation goal of 2%. Eventually, a stronger economy will push up inflation, but that isn’t likely to happen until 2016 or 2017.

Unemployment: As businesses grow more optimistic, job growth will remain strong in 2015, adding about 250,000 jobs a month, on average, compared with 229,000 a month, on average, for 2014 through October.

Many discouraged workers who have given up finding jobs will return to the labor force. I expect the unemployment rate to drop to 5.1% by the end of 2015, the lowest rate since 2008 and down from 5.8% in October 2014. Shrinking unemployment boosts consumer spending.

Outlook for Stocks

I expect the Dow Jones Industrial Average to rise 11% in 2015 and the S&P 500 to gain 13%, including reinvested dividends. Corporate earnings, which are the main driver of the stock market, will likely jump 8% to 9%—more than double the rate in 2014.

In addition, now that investors know that Republicans will be in control of both houses of Congress, much of the political uncertainty is gone and markets generally can count on legislative gridlock for Barack Obama’s final two years as president (except for possible corporate tax reform, which both sides consider important). Investors see this as a positive.

Best areas of the stock market now…

Technology. The ongoing shift toward mobile computing and cloud computing will drive earnings for major technology companies.

Health care. This sector is likely to see strong revenue growth as a result of increased demand for health care from an aging population and the Affordable Care Act.

Consumer discretionary. Employment gains should increase household spending in 2015 and benefit the restaurant, travel and leisure industries.

Outlook for Bonds

Savers finally will get a bit of relief. By the end of 2015, the Federal Reserve likely will push up short-term interest rates to near 1% from virtually 0% in 2014, which will help nudge up rates on savings accounts, certificates of deposit and money-market accounts.

However, bond investors must be very cautious. As interest rates for new bonds rise, existing bonds with lower rates will be worth less unless they are held to maturity.

Bond returns likely will be in the low single digits, at most, and certain categories such as long-term bonds will be very volatile.

I expect 10-year Treasuries will end 2015 with yields of 2.75% to 3% and reach 3.5% to 3.75% by the end of 2016. If so, investors in 10-year Treasuries would see total returns (yields minus loss of face value) of 0% in 2015 and 3% in 2016.

Oil Price Outlook

Oil prices likely will keep falling in 2015 to about $70 per barrel for the benchmark US crude, compared with $95 at the beginning of 2014 and $75 on November 15. That will help push gasoline prices down to a national average of $2.65 a gallon for regular, compared with the 2014 peak level of $3.77 in early June.

In fact, energy prices overall are likely to be subdued for the foreseeable future. This is mainly in response to shifting forces of supply and demand. Emerging markets, which make up one-third of the global economy, are growing by an average of about 4% a year, compared with 6% annual growth from 2000 to 2012.

In addition to sluggish foreign demand, the drilling method called ­hydraulic fracturing, or “fracking,” has pushed US domestic oil production to a 28-year high, including an increase of 50% over the past four years.

Also, because oil prices are denominated in dollars, the sharply rising US dollar has helped push down oil prices.

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