Calculated Risk suggested that there are ten big questions to be answered for 2015. I agree with the list, but I also think there are some additional key questions that have to be addressed. Any investor should think about what should be their answers to these questions; however, forecast at your own peril. The one think we have learned through our systematic trading is that macroeconomic forecasting can be a fool's game. The key is to stick with what the market is telling you and just determine the current state of the world and not try to move to forecasts that are subject to error.
Here is the list of key variables that have to be forecast and some of the major impediments that will face sustainability.
Economic growth - The third quarter growth caught everyone by surprise, but also was within earlier expectations that the second half of the year would be a lift-off period. The question is whether US economic growth will be at the old normal or the new normal in 2015. Can the output gap closed? Unfortunately, the gap between growth and market move is often not strong.
Employment - You have to go back to the 1990's to have an employment year like 2014. 200,000 jobs a month has cut into the backlog of unemployed but the issue is whether there is enough growth to sustain the 200,000 months.
Unemployment - The unemployment rate has fallen faster than what many have forecasted. In fact, it has fallen so fast to 5.8% that the Fed is now focused on slack in inflation as a guide for policy. It is hard to believe that 2015 will continue to see this number decline.
Inflation - US inflation is below the 2% target and heading south on falling oil prices. The question is when will we see the magic 2%. The only way this is possible is for oil prices to increase and growth continues at the rate seen in the third quarter.
Monetary policy - The first increase is expected in mid-2015, but there is enough uncertainty that a delay should not catch the market by complete surprise.
Oil prices - OPEC thinks oil prices will stabilize at the higher price of $80, but the marginal producers are non-OPEC members. The only way for prices to rise is for producers to find current prices worthy of a shutdown in production. This will only occur if there there is further strain in the energy sector with increasing credit problems.
Residential investment - The investment rate for 2014 was below 2% and not like the double digits of the last two years. For new residential investment, the market will have to see prices moving up at the rate seen over the 2011-2013.
Housing prices - The rate of increase in the Case-Shiller index was about 5% for 2014. Not bad for this market, but less than the stock market. If rates are moving higher, it harder to thing the housing prices will return to double digit numbers.
Housing inventory - The inventory numbers are starting to move higher. The dynamics of housing is such that we do not know the real supply that will be available at any price. Many homes have been held back from the market, so it hard to forecast inventory changes.
Wage increases - We have economic growth. We have rising employment. We have tightening in labor, but we do not have increases in real wages. It is hard to see how growth can be sustained if real wages are stagnant.
Bonus questions -
Europe growth - No fiscal policy and and unclear monetary policy makes it hard to determine whether we will see any robust growth in this region.
Japan growth - Abenomics has gotten the stock market higher and the year has fallen nicely but this all to get growth higher.
Chinese growth - The 800 pound economic gorilla will drive commodity markets and capital flows, but how will this work if growth is below 7%.
We may have opinions on these markets but we think that few of the consensus forecast will prove to be true in 12 months. This is the normal situation regardless of how many times we play the end of year prediction game.
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