How To Prepare Your Portfolio For 2015 (Part 3 of 5)

(Continued from Part 2)

In addition to the expected shift in the monetary regime, the rise in volatility is also being driven by more unease from overseas. One area of increasing concern, both politically and economically, is Russia. Oil prices fell another 6% last week, and are now down roughly 45% year-to-date. Lower oil prices will help mitigate the global slowdown, but plunging oil prices are inflicting real harm on several emerging market countries, notably Venezuela and Russia.

Market Realist – There are several reasons why volatility may spike next year.

• Hike in US interest rates: The US economy has been recovering well, as we discussed in the first part of this series. US markets (SPY) have experienced an unnaturally long period of low volatility (VXX). This has often been attributed to the Fed’s accommodative monetary policy. The Fed is expected to tighten its policy by hiking rates next year. This might bring about a surge of volatility as the VIX index returns to its historical average levels of 20. The previous graph shows the Fed’s dot chart, which reflects the expectations of each FOMC member as to the appropriate interest rate.

• Low oil prices: 2014 has been the year of the oil rout. Oil prices (BNO)(USO) have shrunken below $60 a barrel to five-year lows as a result of low demand and a world supply glut. The prices are expected to remain low even continuing into next year in the absence of a supply cut. The subsequent fall in oil prices might cause a volatility spike in 2015. The previous graph shows the precipitous fall in crude oil prices in 2014.

• Weakness in Europe and Japan: Europe (EZU) and Japan (EWJ) both have been struggling in the face of a severe economic slowdown. Japan has officially slid into a recession, with negative GDP growth rates in the past quarters (-1.9% in Q2 2014 and -0.5% in Q3 2014). You can see this trend in the previous graph. The Eurozone narrowly avoided a contraction, with GDP growth rates of near zero. With Greece facing early elections on account of Prime Minister Antonis Samaras failing to get adequate backing for his presidential candidate, the situation seems to be more uncertain than ever. These uncertainties may cause a volatility spike in 2015.

• Rise in geopolitical tensions: While the rise of ISIS, the disappearance of the AirAsia plane, and the Ukraine-Russia conflict still far from resolution, uncertainties continue to plague the world markets (QWLD). A rise in geopolitical tensions could cause the fear gauge to rise and volatility to spike next year.

• Russia: The political and economic situation in Russia has been cause for much of the market turmoil in December. This trend could continue going into 2015.