Last year was a relatively calm year. The market rose in line with earnings. Volatility, as represented by the VIX, remained at the lower end of its long term range.
As 2014 drew to a close, and substantially fewer stocks participated in the uptrend, the market began signaling an end to that calm.
Volatility returns
So while the VIX index averaged 14 for the year of 2014, it has registered an elevated average of 20 so far in 2015. This higher level for VIX is unnerving yet it is the long term historical average for that market measure.
We believe this return to average volatility is one reason to expect market corrections that are deeper than the 5% to 7% pullbacks of the last three years.
Another is valuation. S&P 500 corporate earnings are expected to be $132 for 2015. That values the current market at its long term average of 15 times forward earnings.
Selloff risk
With higher expected volatility and the market fairly valued, we continue to believe this year might see a selloff of as much as 20%.
And though we believe the potential for a dip as severe as that of 2011 may be in the cards, we believe that like 2011, this will be merely an interruption in the long term uptrend of the markets.
That long term uptrend is a reflection of long term growth in corporate earnings. Averaging about 7% over time S&P earnings are slated to grow at about that rate again this year.
Now that markets have reached average valuations anything that puts that growth in doubt will tend to have more impact on the markets. Therefore the upcoming earnings season will become the markets immediate focus.
Trouble spots
In mid-January, companies will start reporting fourth quarter earnings. More importantly companies will be making projections concerning 2015 sales and profits.
While much of what managements have to say is already priced into the market, the dramatic fall of oil, continuing problems in Europe, and elevated costs of Obamacare implementation, contain the seeds of surprise in my opinion.
Although we expect potential unsettling news and concurrent deep market pullbacks we do not think, we are on the brink of another meltdown like that of 2008.
We expect that when all is said and done the market will close out the year 2015 higher than where it started.
Photo Credit: Beyond Neon via Flickr Creative Commons
DISCLAIMER: The investments discussed are held in client accounts as of December 31, 2014. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.
