2013 was a memorable year. It saw the US economy continue to slowly recover from the 2008 financial crisis/recession despite headwinds from the federal spending sequester early in 2013 and the US government shutdown in the fall. Unemployment is still too high, but fell to its lowest level in five years. Congress agreed on a federal budget for the first time since April 2009 and the federal deficit fell to its lowest level since 2008 due to higher tax receipts and lower government spending (source: Congressional Budget Office). The equity markets (basis S&P 500) reached an all-time high due to improving corporate profits and higher valuations (price/earnings ratio).
For 2014 the five major themes I anticipate are:
1. Economy – continued, but slightly expanding, growth in global economic activity, with US GDP growing between 2.5% to 3.5%. Globally, Europe should emerge from recession, new policies in Japan should move its economy forward and China is showing signs of stabilization.
2. Interest Rates – gradually increasing interest rates toward 3.5% (basis US 10yr Treasury) based on the Federal Reserve reducing its monetary stimulus (bond buying) but continuing to hold short-term rates near zero. I expect this to be a slow and incremental process.
3. Inflation – should remain below the Federal Reserve’s target level of 2.5% (basis personal consumption expenditures PCE rate). This should mean that the US dollar appreciates but gold and other inflation sensitive commodities will likely lose value.
4. Stocks – equity market will slowly grind higher based on the improving economy yielding higher corporate profits. However, I do anticipate at least a 10% correction at some point during the year and higher volatility (fluctuations) than we saw in 2013. My target is between 6% and 10% increase for the S&P 500.
5. Bonds – the combination of an improving US economy, a less accommodative Federal Reserve and better potential returns in the equity markets will likely mean 2014 will be a tough year for bond investments. My target for the Barclays Aggregate Bond Index is between 0.0% – 2.5%. I am more concerned about bonds once short-term interest rates start to rise, which I don’t expect until sometime in 2015.
I estimate the probability of these themes occurring at 60%, with a 20% probability that we don’t achieve these targets and a 20% probability we exceed them. Factors that could potentially disrupt global progress include (a) the US reaching its debt ceiling on February 15, 2014 without an agreement to increase it; (b) the Federal Reserve tapering its monetary stimulus too much or too soon; and (c) weaker European countries dragging down the overall European recovery. As always, the impact of unforeseen “black swan” events are unknown. Factors that could help deliver better results primarily relate to global fiscal and monetary policies that are supportive of economic expansion.
I will put out a mid-year report in July 2014 on where we stand versus these themes and make adjustments for the balance of the year accordingly.
Here is an interesting statistic. Since 1945 the S&P 500 has gained more than 20% in a year 17 times. In 14 of the 17 years following these +20% gain years, the S&P 500 has had positive results, with an average gain of 11.27%. See the chart below, courtesy of CNBC. Also of note, the three down years, 1962/1981/1990, were all years when the US was in a recession. While past performance does not guarantee future results, an 82.35% ratio of positive returns is worth noting.
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Sources: RiverFront Investment Group, Nuveen Asset Management
Although information herein has been obtained from sources deemed reliable, its accuracy and completeness are not asserted. All opinions and estimates included in this report constitute the judgment of the financial advisor as of the dates indicated and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.