We wish you a very happy, healthy, and prosperous New Year for 2015 and beyond. Many of us had a tough year in 2014 despite the S&P 500 Index rising 15%. Most diversified portfolios were heavily weighted in oil and biotech, including ours. I'm sure the vast number of money managers had a poor relative performance and that does not mean one should not stick with them in 2015. Two events occurred that no one could have reasonably predicted. First, I was a bear on oil prices thinking that oil would decline from $115 WTI per barrel to $95 WTI per barrel. No one was predicting that oil prices would fall below $60! Second, late in December the biotech industry was hit with the Express Scripts bomb. Express Scripts was granting AbbVie exclusive rights to its newly approved Hepatitis C drug excluding Johnson & Johnson (NYSE:JNJ) and Gilead (NASDAQ:GILD). More importantly this marks a fundamental change that no one was talking about. In exchange for deep discounts, drug administrators and wholesalers will grant exclusivity to a single company. We have serious concerns about the ethics of this practice, but for now it's a way to dramatically cut new drug costs to patients while hurting the sales of the major pharmaceutical and bio-tech companies. Needless to say excluding oil and bio-tech, we would have done quite well in 2014. We look forward to 2015.
2015 should be a tough year for equity investors as the Federal Reserve begins a long awaited tightening policy sometime mid-year. The Fed has signaled that it will not tighten until at least the first quarter of 2015. That means that equities will have the wind to their backs during the first quarter. That does not mean that the first quarter will be good for equities as there will be some dangers. First, oil prices will likely continue under pressure during the first quarter as production does not decline because of hedges on existing production. We have seen some predictions of $30 oil and we cannot argue against that for the first quarter. Production will remain high while demand in China, Russia, Europe and the emerging markets remain weak. We think investors should buy in the oil and gas sector especially the frackers during this projected weakness in the first quarter. We like names like EOG, OXY, and DVN to accumulate during the quarter's commodity weakness. Second, companies that do lots of international business should experience huge currency losses during the fourth quarter that will be reported during the first quarter of 2015. Unless something dramatically changes in the EU, this weakness of the USD should continue into the first quarter. Because we view the US as entering a cycle of rising interest rates, we view a strong USD as here for several years making companies that depend on foreign sales as vulnerable to underperformance. We will be looking for companies that sell primarily to US customers and make their products in emerging markets where currencies are cheap relative to the USD.
During the second quarter of 2015 most people expect the Fed to begin tightening because by then they expect employment to grow substantially with unemployment bottoming around 5% to 5.5%. We believe the Fed will go slow raising rates from 0.25% to 0.50% in their June meeting. We believe the economy will show strength but the market may be spooked a little bit with a small dip in the PE ratio in response to higher interest rates. Without the Fed at their back, only stocks with strong sales and earnings growth will succeed from the second quarter and for several quarters thereafter while PE ratios on the S&P 500 decline from 17 to 15 by year end 2015. We expect the S&P 500 Index that has lots of foreign currency exposure to only rise by 5% during 2015. We expect volatility on the downside of about 20% and upside of only 5% around this projection.
Our contrarian view is that interest rates will stall out at 0.50% during the third quarter and not increase with consensus to 0.75%. This is because we believe that the economic recovery in North America was primarily fueled by the fracking revolution that increased US production by 3 million barrels of oil per day. This brought on huge increases in employment in the oil and gas industries and related that includes autos, trucks, machinery, chemicals, restaurant, hotel, housing, mobile homes, banking and many others. The slowdown in drilling will begin in the third and fourth quarters along with the layoffs. This will keep the employment numbers lower than expected and keep interest rates at 0.50 until year-end 2015. The black swan may be Russia defaulting on its debt during the second half of 2015 as almost all oil hedges roll over. Low oil prices should help consumers and investments in select domestic retail should out-perform. Transportation stocks should also do well as well as any industry that consumes lots of oil and gas.
Disclosure: The author is long CSCO, CVV, NBIX, JE, ALB, OWW, VLO, EOG, DVN, OXY, ABBV, GILD.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.