In 2014, the global market witnessed both growing and shrinking economies, unrest in Eastern Europe, an Ebola outbreak, and falling oil prices. Against this backdrop, the U.S. stock market entered the New Year with the S&P 500 Index positing its third consecutive annual advance of more than 10.0%. The U.S. economy expanded at 5.0% in the third quarter, the fastest pace since 2003, with improved consumer spending and falling imports. Unemployment dropped to 5.6%, the lowest level since June 2008.

Non-U.S. markets struggled to find their footing. Slower growth in Europe and Japan combined with weakened currencies brought losses for U.S.-based investors. Falling energy prices punished oil exporters in emerging markets, primarily Russia and Brazil, and pushed the emerging market equity index to its first back-to-back annual loss in 12 years. The emerging Asian region turned in the best results based on pointed government stimulus, solid domestic consumer demand, and lower energy prices. Intermediate and longer-term Treasuries provided the best returns since 2011, while yields across the Euro zone fell to record lows.

The U.S. stock market continued to provide attractive returns for investors. With a 4.9% increase in the fourth quarter, the S&P 500 Index posted gains for the eighth quarter in a row. Reported earnings exceeded analyst expectations for 77% of the companies in the Index. At year end, the value of the S&P 500 had more than doubled since the March 2009 low. Small cap stocks outperformed large companies in the fourth quarter, but small caps still notably underperformed large caps in 2014. Investors showed a clear preference for “safer” market sectors. Utilities and Consumer Staples were among the top performers of the S&P 500 for the quarter.

International stocks significantly underperformed as demonstrated by a 3.6% drop in the MSCI EAFE Index during the quarter. Poor economic data, deflation concerns, and sluggish growth contributed to disappointing results in Europe and Japan. Moreover, currencies in these regions weakened against the U.S. dollar in response to stimulus efforts by the European Central Bank (ECB) and Japanese government.

Results for emerging markets also proved disappointing as measured by a 4.5% decline in the MSCI Emerging Markets Index, making returns negative for the year. Performance across countries varied widely during the quarter. Uncertainty in Eastern Europe and rapidly falling oil prices contributed to a 32.9% overall drop in Russian stocks. Emerging Asia provided the best results led by China and Taiwan. With lower prices on oil imports, Asian economies enjoyed a substantial boost to economic growth.

U.S. Treasury bonds continue to defy expectations as the 10-year yields declined during the quarter from 2.4% to 2.2%. Yields for U.S. bonds maturing in four years or less rose during the quarter as investors deal with the prospect of the Federal Reserve raising short-term rates in 2015. U.S. bond yields remain higher than several other developed countries, which has helped maintain interested buyers.

The global bond market as measured by the Barclays Global Aggregate Index dropped 1.0% for the quarter. While declining yields increased bond prices, these gains were more than offset by a reduction in the value of global currencies relative to the U.S. dollar. The U.S. dollar appreciated 4.1% relative to the Euro in the fourth quarter.

Investors moved away from the high–yield market in favor of the relative safety of lower risk instruments. The rapid decline in oil prices increased the risk of defaults among energy-related high–yield bonds; investors preferred safety over the incremental return. While defaults were well below average, high–yield bond spreads increased back to their long-term average.

The U.S. economy made a strong showing with GDP growth measured at 5.0% for the third quarter. The unemployment rate dropped from 5.9% to 5.6% during the quarter. Consumer confidence ended the year at the highest level since before the recession. The improving employment outlook, rising home prices, lower fuel costs, low interest rates, and the rising stock market buoyed consumer spending, which accounted for about 70% of U.S. GDP. Household net worth (assets minus liabilities) is now 22.0% higher than the level reached prior to the recession. Cheaper oil and natural gas should also reduce costs for many manufacturers and service companies.

Europe posted meager growth of 0.2% in the third quarter as it recovers slowly from six quarters of economic contraction. No single country grew faster than 0.7%; Italy’s GDP actually shrank 0.1%. The region struggles with high unemployment and high debt levels. Although interest rates remain extremely low, this has failed to produce lower unemployment or faster economic growth.

Japan’s economic stimulus program led to a significant devaluation of the Yen and boosted exports. Inflation, which had been negative for most of the last decade, increased in 2014 in response to the Bank of Japan’s (BOJ) easy money policy. Despite these efforts, the economy contracted in the third quarter as the pre-announced tax increase caused consumers to increase purchases earlier in the year.

The U.S. remains the most attractive market based on economic growth and stability. Rising consumer confidence, modest inflation, and low interest rates offer support for current valuation levels. The earnings outlook calls for low single digit growth in the coming quarters with some acceleration in the back half of the year. Equity valuations are near their long-term averages which implies performance should be primarily driven by earnings growth rather than changes in valuations.

While economic data and stock returns in Europe have been disappointing, lower borrowing costs, a beaten down currency, and stimulus efforts may boost the economy and stock prices. However, investing in the region doesn’t come without risk. Elections are scheduled in at least three countries this year, and concerns are mounting about the future of the single currency. The ECB’s ability and willingness to fight deflation and stagnant growth will be primary drivers of economic growth and stock returns in the coming quarters.

In the developing world, the strongest economic performance continues to come from Asia. China and India are among the fastest growing economies in the world, but current valuations remain reasonable. The decline in oil prices will continue to have differing impact on importers (e.g., China, India) versus exporters (e.g., Russia, Brazil), and could produce wide spreads in returns across countries as money is redistributed from oil exporters to importers.

Global bond yields are trading near the low levels reached in the summer of 2013. The Fed has indicated a desire to raise rates while Europe and Japan are embarking on additional stimulus efforts. There is a lot of uncertainty in the fixed income market as global government intervention is significantly impacting bond yields. Although bond yields could move lower, there isn’t much room to fall, which reduces the likelihood of significant bond price appreciation. Bond returns should be muted and could dip into negative territory in 2015 if global economic growth surprises to the upside.

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