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Common Sense

Those Who Nailed 2014 See Volatility This Year

Duncan Wilkinson, left, chief of AlphaSimplex Group, and Peter Lee, a portfolio manager at the firm, which sees rising risks.Credit...Katherine Taylor for The New York Times

Volatility will be the new normal in 2015.

That’s the overriding theme that emerged in my annual survey of investment professionals who got it right last year. And if this week’s market action is any indicator, their prediction is already being borne out. Stocks soared on Thursday, with the Dow Jones industrial average gaining over 300 points, the fourth straight session of triple-digit moves. Interest rates and oil prices have also gyrated.

Volatility could also be called the old normal, given how common it was before the relatively tranquil years after the financial crisis. “We’re likely to get a lot more volatility than we’ve become used to,” said William Miller, who runs the Legg Mason Opportunity Trust. “Every time we get a correction or even close to it, everybody flips out. I’d say that’s more of an observation than a prediction.”

Mr. Miller returns for a fourth consecutive appearance in this column on the strength of his forecast for the stock market last year. He was far more bullish than most, and said then that he expected the Standard & Poor’s 500-stock index to gain “in the low to midteens,” which turned out to be exactly right. (It gained 13.7 percent.)

“It’s going to be a lot trickier this year,” he told me this week. “But I’m very bullish on the United States economy over all. I’m looking at high single-digit to low double-digit gains for the S.&P. 500, and I could see the S.&P. 500 gain 15 percent if things break the right way. Absent some weird geopolitical thing, I’d be very surprised to see negative returns.”

Volatility was also the forecast, if that’s the right word, at the AlphaSimplex Group in Cambridge, Mass., the research and asset management firm founded by Andrew W. Lo, author of the “adaptive markets hypothesis,” which examined whether markets are rational, and director of M.I.T.’s Laboratory for Financial Engineering. “We don’t forecast rates or valuations,” said Duncan Wilkinson, the firm’s chief executive. That didn’t stop the firm’s Tactical U.S. Market Fund from posting a 14.7 percent return last year, a full percentage above the S.&P. 500.

All of AlphaSimplex’s funds fall into the relatively new but fast-growing category of liquid alternative mutual funds, and serve many of the same purposes as hedge funds but with the lower fees, low minimum investments and daily liquidity of mutual funds. The Tactical Market Fund engages in market timing, moving from a maximum 130 percent exposure to the S.&P. 500 (using derivatives or borrowed capital) when risk is low to all cash when risk is high. So in a sense, the firm’s model does predict price movements.

The approach helped the fund navigate last year’s market, in which about 80 percent of active managers underperformed the S.&P. 500. The reason the fund did so well is simple — it replicates the S.&P. 500 index, stayed fully invested the entire year, and used derivatives to gain 130 percent exposure to the index.

Its quantitative model accurately assessed that risk remained low. “There was some turbulence in October, but our model suggested it was only middling, and it wasn’t time to do anything,” said Peter Lee, senior research scientist and co-portfolio manager of the Tactical Market Fund. “This very disciplined approach has stood us in good stead. It takes the emotion out of investing.”

Whether the fund can repeat last year’s success remains to be seen, since it’s little more than a year old. (AlphaSimplex has two other liquid alternative mutual funds with longer track records and just started a global macrofund.) The firm’s model currently shows that risks in the United States market are rising. “We’re still at 130 percent but we’re close to ratcheting that down,” Mr. Wilkinson said. “We’re watching very carefully for the contagion risk of developed non-U.S. markets.”

Whither Bonds?

If 2014 was a tough year for active stock managers, it was even worse for fixed-income managers. A year ago, almost everyone expected higher rates, including a bearish Bill Gross, a founder of the investment firm Pimco, who told me then that investors should expect “slim pickings" and stick to cash or low-yielding money market funds. (It was an especially turbulent year for Mr. Gross, who abruptly left Pimco and joined Janus Capital Group.) His advice for this year is much the same, “Be cautious and content with low positive returns in 2015,” he recently wrote in his monthly newsletter.

In what has to be considered the biggest market surprise of 2014, interest rates dropped sharply and bonds rallied. The Barclays United States Aggregate Bond Index returned just under 6 percent. United States Treasuries with longer maturities fared even better.

Douglas Kass, president of Seabreeze Partners Management (and a widely followed market analyst), was one of the few to forecast lower rates last year in his annual list of “surprises” for 2015.

This year, in what he called “the polar opposite of what I saw last year,” he’s predicting no less than the “end of the three-decade bull market in bonds,” he told me this week.

“Rates will go lower at first,” he said. “That will shock people, and everyone will throw in the towel on higher rates.” (So far, he seems to be right about that.) But, he said, once people realize that the European Central Bank’s stimulus policies are too little, too late, he expects European rates to rise, followed by those in the United States. “You could see a spike in European rates without any improvement to their economies,” he said. “Italian sovereign debt interest rates are lower than in the United States. That’s insane.”

A fund that capitalized on lower rates last year was Delaware Investments’ Extended Duration Bond Fund, which returned over 17 percent.

This year, Delaware’s fixed-income specialists are predicting a modest rise in rates, to just over 2 percent for 10-year United States Treasuries. “We feel the fundamentals suggest rates can stay in the low 2 percent area, and could end up lower because of dislocation in other markets,” said Roger A. Early, Delaware’s co-head of fixed-income investments.

He said he was “open-minded” about whether the Federal Reserve will raise the federal funds rate this year, as nearly everyone expects.

“With some of the stress we’ve seen, relative to energy and commodity prices, and with deflationary trends in places like Europe, if those continue, I don’t think it’s a given the Fed will move interest rates in the second or third quarter.” (The Fed hinted as much in the minutes of its December meeting that were released this week.)

“The market may be surprised that the Fed takes a step back and doesn’t move forward so quickly,” Mr. Early continued. “We believe United States economic growth is still quite fragile. So current low yields can be sustained for some time.”

Whither Oil Prices?

In nearly every forecast for the year, the wild card is oil. The steep fall in 2014, from more than $100 a barrel to less than $50, surprised and rattled many investors, stoked fears of deflation and battered emerging market economies, even as it put more cash in consumers’ pockets. Almost no one saw it coming, but one who did is Michael Levi, senior fellow for energy at the Council on Foreign Relations and author of “The Power Surge: Energy, Opportunity and the Battle for America’s Future.”

“Early in 2014, oil prices had been high and steady for a long time, and people extrapolated that this would be indefinite,” Dr. Levi told me this week as prices fell below $50 a barrel. “That didn’t make any sense.”

Looking ahead, “Anything is possible,” he cautioned, “but all the conditions for high volatility remain in place. That’s the natural state of the oil market unless a cartel is in control. Part of the lesson from last year is that a small mismatch in supply and demand can result in a large and rapid change in prices. That works in both directions. If there’s an increase in global growth, geopolitical disruptions or a faster shutdown in North American production, then oil prices could definitely go up.”

Nor, he said, should Saudi Arabia’s potential influence be ignored. He noted that the kingdom waited until oil prices got into the $30-a-barrel range before curtailing production in the midst of the financial crisis. “Just because Saudi Arabia hasn’t acted yet doesn’t mean it never will,” he said.

A version of this article appears in print on  , Section B, Page 1 of the New York edition with the headline: Those Who Nailed ’14 See Volatility This Year. Order Reprints | Today’s Paper | Subscribe

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