Well, it’s that time of year again, when all the pundits offer their crystal ball views of the coming new year. I don’t usually participate in the prediction game and this year won’t be any different. Like everyone else I wonder what the future holds but I know I have no special ability to predict how it might unfold. What I generally do – all year, not just when the calendar flips – is look at the world and try to figure out where the risks and opportunities are, where things might not go according to the consensus. For that is where alpha exists, either by avoiding risks readily accepted by others or embracing risks that are being shunned. Identifying these risks/opportunities, the yin and yang, and monitoring them is not the same as making a prediction; crowds can be wise, the consensus is often right and risks are not always realized. But when widely accepted “truths” turn out to be nothing of the sort, when the crowd turns into a mob, when the waste is hitting the rotating wind device is not the time to be formulating a plan. So I worry, fret and think about how things might not go according to plan.

So, as we prepare to enter a new year, here are the questions I’m asking myself:

1. Will the dollar keep rising?

The dollar has been stable to rising basically since 2009. The trend accelerated last year and the implications, which I first warned about a year and a half ago, are now obvious to everyone. Commodity prices have fallen, emerging markets have underperformed and US stocks have outpaced most of the rest of the world. There was a point earlier this year when the trend was on the verge of breaking down but it held and then accelerated into the end of the year. Will this trend continue or reverse and if so, what are the implications? If the dollar trend accelerates does that signal global financial system stress (as it did in 2008) or does it reflect an acceleration in US growth (as it did in the late 90s)? What are the implications for countries and companies with dollar debts built up during the weak dollar period? What are the implications for commodity prices and more specifically the US energy industry? If the dollar keeps rising and oil keeps falling what are the implications for US growth? Will the negative of reduced capital spending on energy overwhelm the positive of reduced energy costs for the rest of the economy? What about geo-political implications? Can Saudi Arabia remain stable with further pressure on oil prices? How will Russia respond to the collapsing Ruble and oil prices?

What would trigger a reversal of the dollar trend? European QE? A deterioration in US growth prospects? If the dollar reverses due to falling US growth expectations, how will commodities respond? Will oil prices recover with a weaker dollar and save the shale companies? Or will they continue to fall if the dollar reverses because of falling US growth expectations? How would gold react? If US growth expectations do fall, how will the Fed react and what impact would that have on the dollar? Will the overwhelmingly bullish consensus on the dollar be right or wrong?

2. Will long term Treasury yields keep falling?

Long term bond yields fell last year despite an overwhelming consensus for the opposite. When I wrote about the bond market consensus last April (and a few other times throughout the year) bond bulls were wholly absent and taking the other side of the trade was a pretty easy call. You don’t get sentiment that lopsided very often. The consensus now is not that different than it was then, although there has been more talk recently about deflation risks. Will bond yields continue to buck the consensus and fall further? How will long term Treasuries react to a rate hike by the Fed (assuming they actually get that far)? If the dollar had a major influence on bonds last year – and I think it did – how will bonds react to a reversal of the dollar trend? Will that depend on why the dollar trend is reversed? If bond yields do continue falling, will it be due to falling inflation expectations or falling growth expectations or both? Or will it be more about fears from outside the US?

3. Will corporate bond spreads keep widening?

Junk bond spreads have been widening lately due to the fallout in the shale industry from lower oil prices. Will spreads widen further? Will mark downs on energy junk debt affect the rest of the market? If defaults start to rise in the energy space will other industry credits also suffer? Will spreads start to widen in non junk debt? If junk bonds keep falling and investors continue to sell junk bond funds, will the lack of liquidity in the bond market (balance sheet constraints at banks due to Dodd Frank) exacerbate the downtrend? How far would spreads have to widen to negatively affect the stock market?

4. Will US stocks continue to outperform?

US stocks have outperformed international stocks since the 2008 crisis (based on S&P 500 vs EAFE). The trend is quite long in the tooth based on history but it is hard to see a reversal right now. The last few years asset allocation has been a net loser; allocating to anything but US stocks has reduced performance. Will US stocks continue to rise despite high valuations? Will US stocks finally see more than a modest pullback, a full blown 10 – 20% correction, something way, way overdue? If corporate bond spreads start to widen, will that affect the buyback trend? Will US growth really accelerate next year as the consensus expects? If it doesn’t can stock price gains continue to outpace both sales and earnings gains? Could stocks enter a full blown bubble phase a la 1999/2000? Will international markets finally outperform this year (even if that doesn’t mean an outright rise)? Will Abenomics in Japan finally bear fruit? Or will they just opt for further devaluation of the Yen? Will other Asian countries respond to a lower Yen? If so, how? Will China continue to slow? Will their accumulation of debt since the crisis be resolved benignly or through crisis? Will China allow the Yuan to fall versus the dollar? Will Europe finally start full blown QE? If they do, how will that affect the Euro, the Dollar and European stocks? If the ECB can’t engage in QE due to political or legal constraints, will the Euro finally start to break apart?

5. Will US growth accelerate as the Fed and everyone else believes?

The US economy has been stuck on a growth path of 2 to 2.5% for the last few years. The Fed and the market expect that to change this year with an increase in spending (capital and consumer) as the catalyst. Will companies shift from stock buybacks to capital spending as long expected? That could have a positive affect on economic growth but will it be positive for stock prices? Will it be enough to offset the now expected drop in energy capital spending? Will consumers spend more on other items with the drop in energy costs or will they add to savings? Will residential real estate investment finally accelerate above the bottom of the long term range? How would expected higher rates affect the economy? Can the US/Global economy handle higher US rates? Can auto sales continue to rise even as they approach previous peaks? Will US wages finally start to rise at a pace significantly above inflation? Will employment be sufficiently robust to start reversing the decline in the participation rate? How would economic weakness abroad affect US growth and earnings? Can the US decouple from the rest of the world?

6. How will politics affect the markets this year?

With a new Republican majority in the Senate, gridlock seems set to continue. That has been good for US markets in the past but with monetary policy now moving toward a tightening will that continue to be so? Will divided government continue to be a positive? Will the President seek to compromise with a Republican congressional majority (or the other way around)? What are the chances of any significant corporate tax reform (based on recent comments by both sides, individual reform seems off the table)? What regulatory measures will we see in the new year and what industries will be affected? How will the drop in oil prices affect energy policy? What will happen with court challenges to Obamacare?

7. How will geopolitics affect markets this year?

What will Putin do now that the Russian economy is faltering on lower oil prices? Will Russia default? Invade other neighbors? Take over Ukraine completely? How would the US respond? Will Venezuela default? Does it matter? What other effects can we expect from lower oil prices? Does Saudi Arabia have sufficient reserves to remain stable if oil prices keep dropping? Will Iran be forced to the bargaining table by low oil prices or will it cause them to lash outward? How would Israel respond? Will China continue to press their claims in the South and East Asian seas? Will Japan respond and if so, how?

I don’t know how all these questions will be answered and some of them may not be answered at all during the next year. We do know what the consensus expects: US growth will accelerate, the ECB will implement full blown QE in Europe, Chinese growth will slow but without a crisis, commodity prices will keep falling, gold prices will keep falling, lower oil and commodity prices will be a positive for global growth, the Fed will hike rates at least once and probably several times, the dollar will continue rising, bond yields will rise, US stocks will have double digit gains again, the Yen will keep falling and Japanese stocks will keep rising. That’s probably not a complete list but certainly covers the major areas. What I know from experience is that at least some of those expectations will be wrong and probably spectacularly so. Which ones and how will determine how significant they are for investors. I know the ones I have my eye on, do you?

This will be my last commentary of the year. I’m headed once again to Chicago for the holidays to be with my daughter. I thank everyone for reading this year and wish you all a Happy Holiday season. See you next year.

Click here to sign up for our free weekly e-newsletter.

“Wealth preservation and accumulation through thoughtful investing.”

For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, Joe Calhoun can be reached at: jyc3@4kb.d43.myftpupload.com or   786-249-3773. You can also book an appointment using our contact form.