Six things for investors to expect in 2015

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The last few years have been pretty much a repeat of the same themes: slower than expected economic growth, stronger than expected bond markets, low interest rates, and surging stocks, especially in defensive sectors.

Get ready for some major changes in 2015. We appear ready to break out of the deeply entrenched patterns that we've come to take for granted.

If – and it's a big if – the American economy continues to expand at the rate it's going, next year's investment climate will be a lot different. That's the view of Stephen Lingard, senior vice-president and portfolio manager for Franklin Templeton Solutions. Here's what to expect.

An end to the bull market in bonds
It was widely expected that bond prices would begin to fall this year, driving yields higher. That hasn't happened, although bonds have shown some weakness in recent weeks. The first-quarter growth setback in North America caused by the bitter winter and a continued flight to safety by overseas investors buying U.S. Treasuries has kept the bond market buoyant. But Mr. Lingard feels the long run is over. "The bond market is the last place to put uncommitted money right now," he says. "We are deemphasizing fixed income securities of any colour."

The return of stock market volatility
It's been three years since we've experienced a market correction. That seems like forever. It may not happen before the end of this year, but it's coming Mr. Lingard says. "By the time we get into 2015, we could see a 10 per cent correction," he said in an interview. The most affected sector could be interest-sensitive stocks like utilities and REITs. They took the brunt of the market pullback in the so-called "taper tantrum" in the spring of 2013 and could be hit again for the same reason.

The rise of the cyclicals
Cyclical stocks – mining, materials, energy, etc. – have lagged in recent years. Low commodity prices and sluggish economic growth have kept these companies in the doldrums. Instead, investors chased yield, driving up the prices on defensive, dividend-paying stocks. If we continue to see normalization in the U.S. economy, that will change. Mr. Lingard first expects to see strength in what he calls the mid-cyclicals, such as industrials, technology, and financials. That will be followed by the late cyclicals, such as resource stocks, which make up a large percentage of the Canadian market.

Cash is king
With bonds due for a downturn and stocks in countries like the U.S. looking pricey, Mr. Lingard has increased the cash positions in the funds he oversees. "It's the prudent course for a bull market that's long in the tooth," he says.

Opportunities abroad
Although the U.S. market looks expensive at this time, Mr. Lingard, a value investor in the Templeton tradition, sees bargains elsewhere in the world, notably Japan. He says stocks in that country are trading at a 50 per cent discount compared to the U.S. on a price-to-book basis. "Japan has done a lot to strengthen its economy but many investors haven't given them credit for it," he says. "On a relative basis, Japan is great value." He also sees growth potential in underpriced emerging markets, noting that we're see stabilization in China. "They've avoided a collapse, at least for 2014 –15."

Geopolitics a drag on Europe
European stocks were underperforming even before events in the Ukraine and concern about the economic effect of increased sanctions on Russia spooked investors. "If that conflict went away, I think there would be a positive effect, with Germany one of the biggest beneficiaries, but I don't think Putin will bend," he says. He adds that European equities are cheap but advises hedging the currency if you invest in them – he believes the euro is headed for a period of weakness. As for the Islamic State, Mr. Lingard says that while its actions are barbarous, they don't appear to be having any effect on markets. "They're trying to throw sand in the global gears but not having much effect."

The bottom line is that change is coming and we need to prepare for it. The strategies that have worked well in recent years probably won't hold up for much longer.