Why 2015 market looks too good to be true

Predictions for 2015
Predictions for 2015   

2015 by most accounts is expected to be a good, but not a great year for the stock market.

The U.S. stock market however, unlike others around the world, is expected to enjoy a "just right" environment of improving growth against a backdrop of tame inflation, low energy prices and low interest rates.

It sounds too good to be true, but then again so did 2014's stock market, which closed out year with solid gains. The Dow ended the year up 7.52 percent, helped by a fourth-quarter gain of 4.58 percent, while the Nasdaq and S&P 500 rose 13.40 percent and 11.39 percent, respectively, for the year.

"This is the most unbelievable market of my life," said Nuveen Asset Management's chief equity strategist, Bob Doll, in a recent interview. "I think '15 is going to be the year we move from disbelief to belief."

The average 2015 forecast of 15 top Wall Street strategists is for a roughly 7.5 percent gain in the S&P 500 to 2,220, fairly modest, but still a decent showing on top of 2014's advance. Underlying those forecasts are also expectations for more volatility, particularly when the Fed moves to raise short-term interest rates.

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Ed Keon, portfolio manager at Quantitative Management Associates, said two factors helped 2014's stock market performance. One was that long-term rates stayed surprisingly low, and the 10-year, starting 2014 with a yield of 3 percent, is ending the year at around 2.16 percent.

The other factor was a shocking more than 50 percent drop in the price of crude oil, a boost to consumers. U.S. crude futures settled Wednesday at $53.27 per barrel.

"I think it's going to be another good year for the market, and a very good year for the U.S. economy," said Keon. "This might be the first year the improvement in the economy is felt by a broader group of people."

The economy certainly has surprised on the upside recently, with third-quarter GDP increasing at an annual rate of 5 percent, on top of the second quarter's 4.6 percent growth rate. Economists have been revising growth forecasts higher but not near those levels.

A woman wears a head band displaying 2015 as she waits for the annual New Year fireworks display on Sydney Harbour Dec. 31, 2014.
Reuters/David Gray
A woman wears a head band displaying 2015 as she waits for the annual New Year fireworks display on Sydney Harbour Dec. 31, 2014.

On Wednesday, Citigroup said it now sees fourth-quarter growth at 3 percent and first-quarter 2015 growth at 4 percent.

"A wide array of economic data has shown a clear pickup in momentum at the end of the year. The uptrend in payroll gains suggests a boost to personal income, factory output has soared and consumers have responded to widespread holiday discounting among retailers. We anticipate a further boost to consumer spending in coming months, due to diminishing energy costs," Citigroup economists wrote.

Oil prices are still seen heading lower, but analysts expect prices to be higher in the second half of 2015. Energy stocks were the worst performers of 2014—down 9.7 percent.

Read MoreWatch for these redflags next year

Keon said 2015 starts off with low oil prices—and low inflation—both positives for stocks. The collapse in crude prices quickly burned the energy sector, but it should have a bigger, positive impact as the falling prices are felt more broadly across the economy, he said.

The outlook for interest rates going into 2015 remains subdued, even with the Fed expected to raise short-term rates just slightly at midyear or later.

Meanwhile, many strategists expect long-term rates—those tied to mortgages and other loans—to stay historically low next year.

2015 All quality: Pro
2015 All quality: Pro   

"We think the short end (of the Treasury yield curve) continues to move higher on Fed speak. It's really the long end we think is going to be anchored by this very expansionary easing that's going on by the ECB (European Central Bank) that's causing very low rates in European markets," said Oppenheimer Asset Management technical analyst Ari Wald. "You can make a case that you're going to see a backup in European rates. It's hard to make a case for higher rates here."

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He expects the 10-year Treasury yield to stay in its current low range, with upside around 2.50 percent for 2015.

"We still like (stocks). When you look at 2014, really it was stealth bear markets in small- and mid-cap stocks. Now you have the Russell 2000 set up to really break higher. I think we could set up for this broad-based breakout with a lot of stocks participating," said Wald. "Nasdaq—that's one of our favorite areas. They're slowly going to make it back to those old highs."

Risk factors

Despite the forecast for a relatively smooth ride, strategists point to potential market volatility around growth scares in China or Europe, where Greek election uncertainty could create more jitters in January. Geopolitical developments in Russia or the Middle East could also rock markets. The rising dollar, if it gains too much upside momentum, could also be a possible risk.

Read MoreWhy Greece won't chill markets

But Keon said one of the biggest risks to the market is its own complacency. "After so many good years in a row, anything we get as an outside shock, it could have a big impact on our market," he said, adding stocks are more vulnerable to volatility.

Wald, however, said one encouraging trend is that the sentiment is not overly optimistic. "There does seem to be some optimism in the market, but I question how much optimism there is. Every time you get a pull back, fear picks up pretty quickly," he said. "I think overall sentiment is pretty mixed here."

A number of strategists are eyeing Europe as a possible opportunity in the next year. The ECB is expected to meet Jan. 22 and there is speculation it will announce a "quantitative easing" bond-buying program.

"So far, we have been really emphasizing the U.S. I do think here will be a trade maybe next year because Europe looks a lot cheaper," Keon said. "There will come a time when that rotation makes sense."