Key spoilers of the 2015 consensus

Predictions for 2015 show the regular habit to extrapolate. America is expected to grow the best, up 2.8% after 2.3% in 2014, with the UK up 2.4% after 3% this year. Harder times are envisaged for developing countries, Russia especially, and China easing its 7.5% growth rate marginally.

But how dependable is all this? Barely six months ago with oil prices around $110, bulls predicted $115-120 and bears $105-100. No-one reckoned on the remotest likelihood of sub-$60, very soon. It shows the dilemma for crystal ball-gazing: how people tend to read the foremost images, but overlook or can't connect others which conflate for knock-on effects or "contagion". For tactical traders, more relevant than forecasts is awareness of key areas of potential instability.

Impact of the oil price plunge on US high-yield debt

If Saudi Arabia and other OPEC oil producers are resolved on damaging the US shale industry then even lower oil prices could follow. And since energy firms have become the dominant issuers in the US high-yield bond market, it implies defaults and falling bond prices with a real risk of contagion. Issuance of US corporate bonds in recent years is estimated to represent 10% of US GDP, most of this high-yield. It is comparable with the mid-2000s credit boom and in the wider corporate sector the proceeds have largely been applied for share buybacks and takeovers.

Yet, according to latest US Fed flow of funds' data, firms have been cash flow negative at the operating level. They are substantially less liquid and more heavily indebted, than consensus estimates. The nub is US firms having an ongoing borrowing requirement to service high-yield debt, making them vulnerable to any credit market shocks. So be aware, US equities are not the low-risk proposition it’s easy to assume from positive earnings reports lately and macro news looking good. This blend of oil prices slump and high-yield debt could spark trouble.

The UK seems yet to fully appreciate the effect of falling North Sea oil revenues on public finance, an issue compounded by the oil industry now requesting tax breaks – as a matter of survival and to limit redundancies. All this implies a knock-on effect in terms of even higher taxes required elsewhere (than the consensus recognises) if the UK is to contain its £1.5 trillion deficit.

Most likely Labour will exploit the Coalition's deficit management in the run-up to May's general election; whether or not Labour has credible alternative policies. It makes sterling riskier to hold, also as the election will bring into question the UK's commitment to the European Union. International investors and currency traders generally see it as a negative that the UK might exit. The only comfort is other fiat currencies facing their own uncertainties.

Net monetary tightening versus record global debt

The Japanese are upping their QE game and Europe is sorely tempted; but no way can they substitute the US Fed's money printing/asset purchase programme which peaked at $85 billion a month. Best estimates are potentially one-third of that stimulus, in a context where expectations are shifting towards medium-term interest rate rises (if only 1-2%). So the net global effect is liable to be monetary tightening.  

Meanwhile lower oil prices reflect "secular stagnation" and nothing has been done to stem the global growth in public/private debt. The Bank for International Settlements has estimated it soared over 40% to US$100 trillion between mid-2007 and mid-2013, while global equities value multiplied from $3.86 trillion to $53.8 trillion.

Governments have been big debt issuers as their spending programmes expanded. During the boom QE years, investors successfully played a theme of governments "muddling through" via a mix of growth, austerity and inflation. But with overall stimulus fading the contradictions in this approach will be exposed. At over 275% of GDP the UK is now the fourth most highly indebted major economy after Japan, Sweden and Canada. The US is on 264% of GDP and China has spiralled from 140% to 220%. Fears over Chinese debt have obviously existed for a few years without a crisis; but it's mostly privately-held, so genuinely high-risk.

Lower oil prices may help net importing nations achieve growth to manage their debts, e.g. some US retailers already cite better sales, but the UK's very high tax on fuel will limit the effect here. Hopefully wages will continue to see some improvement. But altogether the global imbalance of debt and low growth can cause all manner of instability, able to spread.

Rising US dollar to pressure developing countries

The tide of dollars from QE prompted investors to surf for higher returns, including emerging markets. With that tide ebbing as the US economy and dollar strengthen it is creating rip currents in developing countries' debt - typically dollar-based, usually with banks and companies. Add the instability caused by lower oil prices, for the likes of Russia, Nigeria and Venezuela, and the risk grows of knock-on effects. Few investors seem to recall the 1997-98 East Asian financial crisis that spread from local currency issues to stoke fears of world-wide economic meltdown.

This time around, developing countries are more significant to the global economy, possibly about half its output. So while emerging markets' funds look riskier, in due course they may present a buying opportunity. Care is needed with consumer goods shares: while the likes of Unilever may be a useful hedge against sterling, also a play on lower oil prices boosting demand for basic goods, it derives over a third of profit from Asia and other developing countries. So be alert to emerging markets' risk in 2015.

Are corporate profits sustainable as the sugar-rush from QE wears off?

It's easy to worry too much about macro risks: stockmarkets are redeeming so long as companies report positively. In the UK and US there is no real sign of the trend breaking down; prospects may be tough but profits are generally in line with expectations. Warnings have tended to be industry cycle-specific, e.g. electronic component distributors affected by Asian/European price deflation, and demand for US farming machinery hit by special factors in agriculture.

Oil industry services shares have understandably been battered. The big question is whether dividend payout policies will start to get compromised: stock-picking has rightly re-focused on security of dividends, and with interest rates likely to rise only modestly the search for yield will remain a critical factor. For so long as there are plenty of stocks yielding 3-5%, backed by sound cash flow, "buy the dips" will apply during 2015 - say if any of the above risk factors erupt. But if more caution creeps into outlook statements, analysts question the extent of payouts and dividends look under pressure, equities will de-price to where yields are fair compensation for the risks.

While this perspective may come across as negative, it should be a boon for traders. Markets have for too long lacked volatility as a result of QE: shocks to the financial system will mean opportunities for those nimble on the short side, and better value for buyers prudently conserving cash.