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5 unexpected investment predictions for the second half of 2015

The economy will strengthen, extending the bull market in stocks

The first half of 2015 carried a full year’s worth of financial news.

There was the rise and fall of Chinese equities, the threat of Europe imploding on a Greek default and Silicon Valley insiders acknowledging that the technology sector is looking bubbly.

Oh, yeah, and apparently the Federal Reserve could do something at some point. Maybe.

Interestingly, the S&P 500 Index is little changed this year. Even more confusing is that amid those dramatic headlines, stock market volatility remained modest, with the VIX “fear index” at the lowest level in over a year until recently.

So what can we expect in the second half of the year? Are the bulls going to stay in charge, with Wall Street continuing to shrug off bad news as the U.S. recovery remains a durable driver of growth? Or has the beginning of 2015 simply been the calm before the storm?

History shows that pundits who make bold, aggressive calls are frequently proven dead wrong, but there are a few scenarios that I think are highly likely in the second half of 2015. And that could create windfall profits for investors on the right side of the trade.

So at the risk of creating yet another public record of my inaccuracies, here are five predictions of what I expect to transpire from now until the end of December.

Europe will be fine, with or without Greece

We’ll start here, because the ongoing debt crisis in Greece seems to be a never-ending source of hysterics.

In a nutshell: Just because people who haven’t been paying attention to the eurozone for five years are freaking out doesn’t mean you have to.

For the record, a “Grexit” is not a foregone conclusion — heck, the people haven’t even voted on bailout terms yet, and even when they do the nation is prepared to block expulsion from the eurozone via court action. But even if Greece eventually returns to the drachma, the contagion risks we’ve heard so much of lately should be taken with a grain of salt.

Politicians have been preparing for this — and more importantly, so have investors.

After all, it was over four years ago that Fortune ran an article with the headline, “End of the line: What a Greek default means,” with a subhead warning: “Its impact on European banks could trigger a liquidity crisis felt around the globe.”

If you are just hearing about Greece’s debt problems and default risk for the first time, then you simply haven’t been paying attention.

Besides, even if some yutzes are unprepared, Greece’s economy isn’t even in the top 40, according to IMF data, making it smaller than the Philippines or Chile. Heck, Argentina’s economy is roughly twice the size of Greece’s, and its debt default didn’t cause the end of Western civilization.

I won’t pretend this will be easy, particularly for frustrated Greek people who have suffered through a steady economic decline since 2008.

But as financial pundit extraordinaire Jeff Macke put it on Twitter: “The problem with betting on the end of the world is there’s no where to collect if you’re right.”

There may be plenty of volatility in the days ahead, but I still will be making my regular investment in the Vanguard Total International Stock ETF VXUS, +0.24%as I do every month.

Europe has survived worse than this, and it will survive this too. Long-term investors should not abandon exposure to the region, particularly in 401(k) or IRA accounts where they will be “averaging in” across the coming months and years.

U.S. growth will be even stronger

The year got off to a bumpy start after a GDP contraction in the first quarter. As a result, the bears came out in full force with their recession calls.

But if the first half was characterized by disappointment, the second half of 2015 will be marked by acceleration as the U.S. economy gets its groove back.

For starters, some of the details from those early months hint at delayedeconomic activity — not lost activity. Consider the slow inventory build in the first quarter as a perfect example. We’ve seen this movie before, including an initial 2.9% rate of decline a year earlier — the most in five years — that sparked similar doomsday calls. But that was eventually revised to just a 2.1% decline and was followed by a brisk 4.6% pace in the second quarter.

But don’t just take my word for it. Goldman Sachs recently revised its full-year GDP target higher and is expecting a 3% pace of growth in the second half. Also, Merrill Lynch just revised up its 2015 forecast to 2.9% from 2.3% growth. And while the World Bank wasn’t quite so hot, recently revising down its forecast of U.S. growth, the agency still is plotting a 2.7% growth rate for 2015 even after a weak start to the year.

Just consider the jobs numbers as proof of how durable the recovery is. More than 2.95 million jobs were created last year, making 2014 the best jobs year since 1999. And while some folks were mighty scared after a slow start to 2015, May’s jobs report blew the doors off with 280,000 jobs created and increased participation and wages.

In short, expect a powerful finish to the year despite a slow start to 2015. The story of this frustratingly slow recovery from the financial crisis has been one of fits and starts, but it is indeed a story of recovery. I expect the data to continue to point higher in the second half of the year and reinforce a narrative of growth, not one of a slowdown.

Interest rates aren’t going anywhere

Back in April, I said the 10-year Treasury wouldn’t top 2.5%, and I guess, technically, I was proven wrong on June 10 when it hit exactly that mark.

But I remain convinced that low rates are here to stay, and that any brief pop to 2.5% or slightly higher won’t last long.

That’s because while I do believe economic activity is looking up, it isn’t a slam dunk for the Federal Reserve to raise rates. In fact, New York Fed President William Dudley warned in April that “there are reasons to err on the side of being late than being early.” Elsewhere in the world, the IMF just cautioned the U.S. central bank should wait until mid-2016.

Everyone making rate forecasts over the past decade or so has been way off the mark, typically jumping the gun compared to when rate moves actually happen, and it looks like it’ll be the same story this time.

Plus, when you add in the instability caused by trouble in Greece and China, it’s clear that the U.S. remains very much in favor around the world as a safe haven. As a result, investor demand for Treasuries should naturally keep rates lower for the foreseeable future.

This doesn’t mean we can’t see rates move higher, as we have so far this year. But I do not anticipate aggressive tightening by the Fed, nor do I expect international investors to shun U.S. Treasuries in favor of some other asset. I mean, where do you propose they turn?

For those reasons, the rate on the 10-year T-note should finish the year around where it is. And while other key interest rates could be a bit volatile amid global uncertainty and continued hand wringing about what the Fed will do, don’t expect a big move higher.

At this rate I’d be surprised if the Federal Reserve even bumped up the fed funds rate before December.

China will keep sinking

While some people will accuse me of wearing rose-colored glasses in regard to the U.S. and Europe, I don’t expect that kind of criticism about my take on China.

Because China is a disaster waiting to happen — and it will get worse there before it gets better.

A huge run-up in Chinese stocks to start this year might have come on mild optimism, but as the rally wore on, it was clear that investors were wholly reliant on hopes that a stimulus would jolt the economy back into growth. That’s why Chinese-listed small-caps saw the lion’s share of the gains.

But the vertical climb couldn’t last, with valuations getting downright ridiculous. Near the peak a few weeks ago, tech stocks on average traded for more than 220 forward earnings!

We’ve already seen China stocks correct. The Shanghai Composite is now officially in bear market mode after a 20%-plus selloff since mid-June. Diversified ETFs for U.S. investors haven’t fared quite that badly, but they’re still battered. The iShares China Large-Cap ETF FXI, +0.17% the largest player in the industry with some $8 billion in assets, is off only about 14% from its peak, for instance.

But if you’re thinking of buying on the cheap here, think again.

So-called “A-shares” listed on Shanghai and Shenzhen exchanges are expected to post their lowest earnings growth in three years, with the financial sector, struggling amid bad debts, acting as one of the biggest drags. The so-called “debt bomb” of over-leveraged Chinese consumers, corporations and government has topped 280% of GDP, according to recent estimates by McKinsey & Co., and any serious downturn risks one hell of a margin call that leaves this Asian economy in ruins.

That downturn appears to be on the way, too, with falling manufacturer prices prompting fears of deflation. And to top it off, growth may be overly optimistic because of a data error. According to Capital Economics, China overstated GDP expansion by as much as 1 to 2 percentage points, pegging the first quarter’s annualized growth rate at more like 5% to 6%.

Beijing will continue to throw the kitchen sink at this mess, as it has by cutting rates three times in the past several months. However, even the opaque and notoriously corrupt government of China can’t spackle over this problem.

China is going to come to grips with its debts and the end of its breakneck growth in the next year or so, and it will not be pretty.

This bull market won’t end

Even amid this bleak outlook for China, there is actually quite a lot to be optimistic about right now in regard to the global market and U.S. stocks in particular.

As I wrote a few weeks back, the U.S. housing market remains strong and will continue to support both the labor market via construction jobs and the “wealth effect” in American households for the rest of the year.

U.S. consumers, a backbone of growth at home and abroad, continue to be confident. In fact, the latest data show that Americans are increasing their spending at the fastest rate in nearly six years.

And while some bears continue to fret over valuation, the bottom line is that any data you cherry-pick from 90 years can be offset by selective screening on the other side — like this “inverted P/E vs. bond yields” calculation that shows stocks are actually pretty cheap.

Let’s not forget, either, that there are few alternatives for investors than U.S. stocks in an environment where interest rates are racing to zero around the globe.

This is not to say we won’t see some bumps along the way. But remember that in both 2010 and 2012, we saw significant intra-year declines of roughly 10% or more, but still finished the year up by double digits on the calendar year. Even the European debt crisis of 2011 didn’t cause the market to fall apart as major indices finished the year roughly flat despite a steep midyear decline.

With apologies to the bears, it’s downright silly to expect a rally to end simply because it’s gone on for a while. Consider the raging bull market of 1987 to 2000, which lasted 4,494 days and saw a 585% increase in the S&P 500.

Forecasting is hardly an exact science, of course, and there are plenty of reasons to stay skeptical in the second half of 2015. But that doesn’t have to mean abandoning U.S. stocks.

I’m sure that I’ll be proven wrong in many ways in the second half of the year. But at least I’m self-aware, and have read enough to know Wall Street is littered with the corpses of top-callers who were painfully wrong.

 MarketWatch