Investors enjoyed a pretty smooth and very rewarding ride throughout most of 2014, as both bond and equity markets delivered strong returns. The big game changer came in the latter half of the year with the dramatic decline in oil prices.

Cheap oil is unquestionably a huge boon for consumers and the global economy as a whole. Having said that, a 50% collapse in such a key commodity is bound to create significant disruptions. Certainly for the oil-producing nations, such a huge decline in revenues is going to cause a lot of pain – as we know only too well here in Canada. For the global economy, the biggest risk is the potential contagion that can come of a rapid and steep decline in prices like this.

Cross currents

So as 2015 unfolds, the new economics of oil will be a key factor affecting global economies and markets. In addition, with the recent elections in Greece, there is renewed political uncertainty in the Eurozone, not good news in a region that continues to be dogged by unsustainable levels of debt and double-digit unemployment. The concern now is that politics might again override the slow-moving process of economic rebalancing that is needed in Europe.

On the upside, the US economy is surging ahead. And as long as China, the world’s 2nd largest economy, continues to focus on internal restructuring, it is the US that is likely to lead global economic growth for the foreseeable future. What’s more, in contrast to Europe, Japan, Canada and elsewhere, where Central banks are easing monetary policy to stimulate growth, it is widely expected that the US Federal Reserve will buck the global trend and announce interest rate hikes later in the year.

As the US economy grows in strength, monetary tightening of this nature is to be expected and on many levels it is a good sign. But, of course, the markets never like increases in interest rates. Fortunately, in the context of the global economy, any move by the Federal Reserve is likely to be both minimal and very gradual.

All in all, after a brief period of synchronized global economic growth, we are now seeing the world’s economies diverge and begin moving in different directions. The result is a number of cross currents that present both new challenges and new opportunities for investors – not to mention plenty of market volatility!

US & Foreign stock markets lead

Despite heightened market volatility, the investment outlook for 2015 remains positive. Equities are likely to outperform bonds again this year – albeit with more modest returns. And it is foreign stock markets which remain the most attractive. The US market has the strength of economic momentum. In the Eurozone, despite persistent underlying imbalances, market observers are looking to additional monetary stimulus, a lower Euro and of course, cheap oil, to propel values higher.

On the heels of six straight years of increases, it is hard to believe that US stocks (reflected in the S&P 500 benchmark index) might be destined to set a new historical record, adding a seventh straight year to the current tally. Hard to believe, and of course history tells us that if something cannot go on forever, it will eventually stop. But, with the US economy powering forward, bond yields at historic lows, and cheap oil to stimulate consumer demand…let’s just say this bull probably has a bit more to run.

End of commodity boom

Here on the home turf, we are seeing a rather different story. The surprise cut in interest rates by the Bank of Canada in January shows just how vulnerable our Canadian economy remains to the kind of volatility in the price of oil and other commodities such as we have been experiencing. And if the overall economy is vulnerable in this way, our stock market is even more so.

Consider that financials together with energy and materials stocks make up more than 60% of the overall Canadian stock market. And these days, Canadian banks are tending to trade just like oil stocks, riding the ups and downs of the price of oil. The relative dearth of diversification in the Canadian stock market is not new. But for many years, the weak US dollar and the boom in commodities served to mask this vulnerability. Now investors of Canadian securities are getting the wake-up call.

So what should we expect going forward? There is really not a lot of consensus on this. So I can only offer the opinion of those market observers whose analysis I trust. The Signature team of money managers at CI Investments are among those precious few. They view the collapse in the price of oil, preceded a year ago by the drop in the price of gold, as “structural” in nature. That means this is not just a blip that will quickly correct itself. We are seeing, they argue, the end of a commodity super-cycle, led by the explosive growth in demand out of China. Now that demand is waning and as a result…. ”The 2010’s have not been and will not be Canada’s decade, (not) from a market exposure perspective.” (Drummond Brodeur, Portfolio Manager and Global Strategist, Signature Global Asset Management – January 9, 2015)

And if you have been postponing your winter vacation to Florida, in anticipation of a rebound in the value of the loonie, don’t wait! We all need a break from this long and demanding winter…and with the Bank of Canada (BOC) hinting at another cut in interest rates, the CDN dollar is only likely to lose more value. This is part of the current monetary policy in Canada, to keep the Canadian dollar low in order to encourage exports. So take that vacation!