The US economy continued to strengthen in the fourth quarter of 2014. Further momentum in the domestic automobile sector, particularly from truck sales, resulted in annualized vehicle sales of 17 million, very close to the all-time highs of 2005. Gross Domestic Product advanced 5.0% in the third quarter, the strongest performance since the recession of 2009. Consumer Confidence reached 92.6, up from 77.5 a year ago, a very sharp confirmation that the economy is on an upward track. Other economic indicators, including inventory levels, operating ratios, and vendor performance all confirm that the recovery is strengthening.

As positive as the news is on the domestic economy, the rest of the world has experienced a sudden, and in some cases, sharp contraction. European economies have retreated, particularly in Italy, Greece, and France. European central bankers have responded by dropping interest rates, which are now lower than those in the United States, signaling weakness and significant deflationary trends. In some of these southern European economies, unemployment rates for those under 25 now exceed 20%.

The news in Asia is also trending downward as the region’s growth rate has slowed significantly. However, GDPs are at least still increasing over last year’s levels.

The dramatic fall in oil prices in the last couple of months is the most significant development of 2014. The combination of slower growth outside of the United States and large increases in production in shale oil and fracking output has, at least in the short-term, lead to an imbalance in the supply/demand relationship resulting in a fall from $106 in June to $53 at year-end. Since there are 42 gallons in a barrel of oil, the 50% decline translates to more than a dollar at the pump. More importantly, each penny of decline of gasoline equals $1 billion in the consumer’s pocket. If the price of oil holds, the decline in gasoline prices translates into $100 – $125 billion into the pockets of American consumers, effectively a tax cut. This boost will clearly add to our economic growth in 2015, raising our forecast to 3-4% for next year.

The sharp fall in oil prices and the slowdown in the rest of the world economic prospects suggests that inflation will remain low in 2015. Low inflation will mean that any significant increase in interest rates will be delayed until the second half of 2015. Given the current level of bond interest rates (see chart on page 4), we would be surprised if we see the 6% total return that has historically been associated with fixed income.

The Russian economy has probably suffered the most. Collapsing oil prices and Western economic sanctions related to the seizure of portions of the Ukraine have devastated the Russian economy. The ruble has fallen 42% relative to the dollar, effectively doubling import costs and causing an inflationary bubble. The Russian Central Bank has responded by raising interest rates to 17% to stem a run on the currency. This almost assuredly will cause a serious recession in that economy in 2015. When this last happened in 1989, Gorbachev fell, as did the Communist empire.

Stocks, as measured by the Dow Jones Industrial Average, produced a total return of 10.1% in 2014 and exceeded 18,000. It was, as we said, a return equivalent to historical levels. Looking to 2015, we have lowered our earnings expectations due to reduced profits from the energy sector. This sector represents 8.4% of the S&P 500 down from 10.9% in June and appears to us to be a developing area of opportunity. Overall, we expect earnings to increase 6% to 8% in 2015 and we expect share prices to produce gains of 7% to 9% putting the Dow at 19,000 – 19,500. As measured against the 10-year Treasury, which closed the year yielding 2.17%, stocks should generate a very competitive return.

In closing, this was a significant year in the history of the firm as we relocated from our original location to our new offices in Hunt Valley. We strengthened our staff with the addition of Chad Meyer, and we enter our 20th anniversary year optimistic for the economy and our firm’s future.