“Now the water’s wide and deep and brown.  She’s crossing muddy waters”- John Hiatt 

Yes, it’s that time of year. The pundits and experts take out their crystal balls and tell you exactly what is going to happen next year. Where will the Dow close? The S&P?  What will be the interest rate on the 10 year Treasury? You will hear incredibly convincing arguments telling you exactly the opposite things, but all delivered with certainty and gravitas.

We have our forecast for you too! Sadly, we have no idea what next year will bring (and we are quite sure neither do the pundits you will encounter in the media). We do know that markets will be moved by the unexpected and unpredictable changes that 2015 brings. When you go to the doctor (an expert on your body similar to all the experts on the economy), does he tell you what will happen to your body next year? Does he tell you if you will get the flu, have an infection, or break a bone in an accident? I didn’t think so. He gives you a current physical and lets you know the current state of your health. So, let’s be real and give you our view of the current state of the economy’s health. We have no idea how that will play out in the short run, but believe it matters for the longer term.

The economy may be as difficult to assess as in any time during our lives. It is true that we have been having slow growth and gradually improving conditions since March of 2009. It is also true, that in order to achieve that slow growth we have had almost every government in the world lending a helping hand by keeping money cheap. So, we have had governments spending a lot of fuel (i.e. keeping interest rates artificially low to encourage growth) to barely move the economy down the road. This long period of easing by governments in order to support private sector growth is unprecedented in its length and depth. These programs have undoubtedly supported rising equity prices in the United States and muddied anyone’s ability to determine what should be the fair value of an investment. What happens when governments unwind these programs? Since we have never been in a situation quite like this, nobody knows for sure. That should at least serve as a caution in evaluating risks and rewards due investors in the future.

In taking the temperature of the economy, it appears to be lukewarm. In taking the temperature of the US stock market, it seems to be much hotter than that. Is there a disconnect between these two? Not necessarily, but it is not a sustainable long term idea and that is another caution sign. Remember that all long term stock market  returns come from dividends, earnings, earnings growth, and valuations (i.e. how much are you willing to pay for a dollar’s worth of investment return in a year). Second, things tend to go back to normal over longer time periods. For instance, if stocks are given much lower valuations than normal by the current market, they are likely to return towards normal overtime. This would mean that your investment in an undervalued market is likely to do better than normal. Of course, the opposite is true if you buy into a market with higher than normal valuations.

So, here is our current market pulse. US stocks appear to be priced at somewhat above normal valuations, especially given the slow growth and caution signs in the economy. Most bonds appear to also be expensive, with historically low yields. Emerging markets, European stocks, foreign currencies, and most commodities have suffered through rather dismal results compared to US stocks. There are certainly rational concerns about these markets which have fostered sell offs. That said, righting the economic ship would probably mean robust investment results for these areas and lesser results for US stocks and bonds going forward.

As we began, we have no idea of what 2015 will bring to investors. Therefore, we believe that keeping a super diversified portfolio (owning some of everything) and owning a little more of less expensive assets and a little less of highly priced assets will be the prudent course for 2015. And all the other years to come.

By Ted Schwartz, CFP©