Attempting to forecast market performance can be a fool's errand. Criteria are frequently ambiguous. Perspective is regularly irrational. Choosing to forecast, in and of itself, is customarily trying to tie down an endlessly moving target. Nonetheless, investors, analysts, and economists pursue this task on a daily basis. The decisions we make are largely determined by the future we anticipate. When we're right, the end results are triumphant. When we're wrong, we're painstakingly critical of ourselves. It's a revolving cycle of pride and disappointment. It is not for the faint of heart.
This article will examine a series of market indicators; some orthodox, and some unorthodox. The objective is to offer a measured prediction of what investors should expect to see in 2014. Some details will appear redundant, and others will appear irrelevant. The end result will be a forecast erected from the debris left behind. Let the examination begin.
What History Tells Us
The stock market has long been a bipolar entity dependent on both rationality and irrationality. On some days its performance is congruent with expectations. On other days, its performance appears completely void of any rhyme or reason. However when one steps back from the day to day volatility, and views the market from a broader perspective, its presentation appears much more reasonable. Like most social organisms, the market is precarious in the short term and predictable in the long term. So when one begins the process of looking forward, one must first look back.
In 1933 the U.S. stock market grew 66.7%. It closed at 99.90, up from the previous annual close of 59.00. Over that same year, the GDP grew 10.89%. It was a progressive year in America. Academic historians tend to credit this exponential growth to President Roosevelt and his New Deal policies. However economic historians see this growth as a byproduct of a far less idealistic circumstance. This growth was the result the nation's inevitable emergence from the stock market crash of 1929. It simply took until 1933 for the market to offer investors a calculable response. Furthermore, while the 1933 rally was substantial, its end result proved there was far more work to be done. The 1933 annual close of 99.90 was still less than a third of the 1928 annual close of 300.00. In other words, the rally had begun with a bang, but it was still in the early stages.
It would require another 21 years before the stock market would close at a price higher than in 1928. In 1954, powered by automobile sales and suburban relocation, the market finally closed above 300.00. In that year the markets closed at 404.39.
En route to 1954 the markets would grow progressively, if not hesitantly. The 1933 growth continued into the first quarter of 1934, before experiencing a moderate six month pull back. It would close that year just a few dollars ahead of 1933. The growth had held, but not been duplicated. The markets then continued onward and upward until the early part of 1938. In hindsight, the historic growth of 1933 had initiated a bull run which proved to last five years.
The modern era would continue to prove that the universal catalyst for significant market runs was desolation. Epic growth and profitability almost always followed depressed and unwelcoming times. The 1973/74 Arab Oil Embargo was followed by 38.3% gains in 1975. The 1987 crash was followed by a decade of growth fueled by the establishment of the World Trade Organization in 1995, and the beginning of the dot com bonanza. The latter of which eventually led to an all-time market high at that time.
The historic indicators tell a redundant story. It is a story of economic woe, followed by significant short term growth, shadowed by short term pull back, and then consistent multi-year progression. Therefore, if one was to evaluate the last half decade of America's economic story, taking into account the Great Recession, as well as this year's market growth to date of approximately 20%, they could draw the following conclusion; the markets will pull back in the second and third quarter of 2014, resulting in meager annual gains. Of course, this conclusion would be both shortsighted and premature.
The Objective Data
The global economy is recovering. It is not recovering quickly, and it is not recovering without skepticism, but it is, nonetheless, recovering. Signs of life exist in industrial Italy. Germany has flirted with mild inflation. Electronic imports have grown 2.9% this year in South Korea and Taiwan. Japan's composite economic index just recently hit a five year high. Even the Nigerian Stock Exchange is on pace for 35% annual growth in 2013. However, this global recovery is lethargic at best.
Conditions in the United States are not comparably much different. However, this fact raises an interesting question. If the economic condition in America is sluggishly similar to those conditions around the world, then why has the market seen such substantial growth this year? The answer is simple; investors don't have many other options.
The lack of viable investment vehicles around the world in stable, safe, reputable national economies, has led to an influx of foreign investment into the U.S. stock market this year. Admittedly, this trend has manufactured some minor market inflation. However, it has not done so at a rate that would indicate any dramatic pull back from those investors. After all, where else, as it stands currently, would investors go with their money? European markets are, in all likelihood, still two years away from any significant growth. Japan, despite wishful thinking, remains home to a zombie economy incapable of significant market stimulus. China, which may be growing thanks to foreign development and increasing exports, still needs to strengthen their domestic currency before their markets become anything other than speculative. Thus, the U.S. stock market, despite its own slothful economy, has proven to be the best, non-emerging market option for investors in 2013.
This should be a source of encouragement for the U.S market. If the stock market hasn't been performing because of a healthy economy; it has been performing in spite of such. Therefore, it stands to reason, that if domestic markets have shown substantial growth based on manufactured strength, then progress should continue upward with the re-emergence of legitimate strength. Thus, 2013 can be perceived as a foreshadowing of what could exist down the road with true economic recovery.
That being said, the U.S. economy has recently begun to show signs of life. Between July and September the economy expanded at an annual rate of 2.8%. Exports were up, home construction increased, mortgage applications grew, consumer activity improved, and local governments were spending money at the highest rate in four years. All of this occurred despite the fact that the debt ceiling was threatened, and a polarized government proved incapable of any progress. In the event that a long-term solution to this historic bureaucratic divide can be found during the first quarter of 2014, then the U.S. economy may be in possession of the catalyst it needs to stimulate healthy, long-term growth. However these facts, much like the consideration of historical references cited above, do not tell the entire story. The economy is not just an objective mountain of empiricism. There is another facet to it which often goes overlooked and undervalued.
The Behavioral Economy
For those of you who have read any of my previous articles, you are aware that my approach to market analysis is slightly unorthodox. I am a proponent of behavioral finance theory. Therefore, I study, analyze, and predict the market implications of social behavior pertaining to the evolution of human conduct. I tend to prioritize the value of what happens slightly less than why it happened. I believe the predictability of the market depends heavily on the predictability of human behavior. That belief system, not discounting the objective and traditional means of forecasting, has led me to conclude that the economy is capable of being analyzed the same as any other social organism.
Consider for a moment the reciprocity that exists between the market and the social construct. Just as people respond to the market, the market responds to people. People push limits, the market pushes limits. People have good days, the market has good days. People get depressed, the market can get depressed. You get the idea. The point is this; it is not a one way relationship. One is not always the cause, and the other the effect. The relationship is, instead, self-sustaining and reciprocal. Therefore, as people evolve, the market evolves with it. Thus, when one forecasts the future of the market, they must consider the evolution of the human condition.
I am reminded of the infamous words of Gordon Gecko, the iconic antagonist of the 1987 film Wall Street. In perhaps his most memorable monologue from that film he stated the following:
"The point is, ladies and gentleman, that greed, for lack of a better word, is good. Greed is right, greed works. Greed clarifies, cuts through, and captures the essence of the evolutionary spirit. Greed, in all of its forms; greed for life, for money, for love, for knowledge, has marked the upward surge of mankind."
He's not wrong. History can attest to that. However, in today's behavioral economy, he may have never been more right. There is a new generation of investor having a profound effect on the market. This investor is bold, confident, and averse to fear. This investor is greedy, hungry, and rarely, if ever, satisfied. Decades ago this type of investor was a rare and seasoned titan of industry, situated on the top floor of their Manhattan offices. Today, this investor is all too common, and is conducting their business from their tablet while dividing their time between running their own business and promoting themselves on the web. It is a colossal shift in investor identity.
This evolutionary change in generational behavior has dramatically transformed investor expectations. In previous era's, whether it was during Roosevelt's day, the baby boom, or even Reaganomics, a 12-15% annual return was worthy of cul-de-sac bragging rights. Today however, such return on investment would be largely considered a disappointment. This new population of investors has their own set of non-negotiable expectations and they are channeling their inner most Gordon Gecko's on a daily basis.
This mindset is best represented in a brief anecdote from my personal experience. Years back I hired a young woman to work for me in an administrative capacity. She was capable and trustworthy, although not the most academically qualified. She worked for me for a year while I assisted in bringing an MTA to fruition. At the conclusion of the assignment, I moved onto a new client, and she returned to her own professional life. In 2008 she reached out to me after almost two years. She had been out of work for 18 months and was in need of advice, guidance, and direction. As the conversation progressed, I eventually asked her a simple question; why had she been out of work for so long? Her response was as shocking as it was audacious. She casually and without hesitation replied to me as follows:
"I won't even get out of bed and put my heels on in the morning for less than 100 grand a year."
That was it. That was the moment when I had become fully cognizant of the fact that the new population driving the economy was simply different than what society had become accustom to. I had studied emerging behavioral patterns, and had devoted significant time to the study of social evolution, but it didn't really hit me until that moment. She was 27. She was a community college graduate. She was in possession of no specialized skill set. She was also the embodiment of her peer group. She was driven by reckless ambition and free from rationality. She was part of a generation that appeared to be pre-wired for expectations beyond reason. I didn't fully understand it, but that didn't matter in the least. This mindset was going to grow more pervasive regardless of my objections.
After further contemplation and assessment I came to the conclusion that this new mindset wasn't necessarily a bad thing. In both the market and the labor force this unbridled ambition could prove to be a long term catalyst.
In terms of the market, investors are far less likely to sell a position after a 10% or 15% gain. In fact, because of the narcissistic tendencies that accompany this new school of thought, investors are more likely to buy down their cost basis during steep decline, than they are to sell off their positions for a moderate profit. This keeps capital flowing into the market in down times, and prevents it from being withdrawn during merely good times. The end result is irrationality fueling growth. Essentially, the market is being powered in part by audacity, over-confidence, and greed.
This new mindset is changing the labor force as well. Innovation, mobility, and entrepreneurship are flourishing at unprecedented levels. The Mark Zuckerbergs of the world aren't struggling to furnish their first apartments and aspiring to become corporate executives in 20 years. They're dropping out of Ivy League schools, designing innovative technologies, and buying their entire neighborhoods in order to ensure their own privacy. Even the less than "Zuckerbergian" among the crowd still possess lofty expectations. The ones that do enter corporate America want rewards, and they want them now. The members of this new age work force are foregoing marriage, families, and social lives in favor of rapid ascension up the corporate ladder. They'll worry about families and friends once they've made their first million. This level of innovation, courage, and ambition is driving competition, growth, and industry at a relentless pace.
All of this is relevant to the behavioral economy. In reciprocal circumstances, once the market stops dictating the people, the people start dictating the market. Over the last half decade the market has dictated the people. Consumer confidence has been low, economic fears have been high, and uncertainty has led to reluctance. However, now that the market has started to recover, and fear has started to subside, the people are starting to drive the market. In that last half decade this new generation of investors has come into their own, and they are the ones leading this new driving force.
History tells us that our 20% YTD growth is largely a result of our re-emergence from dire circumstance. Statistics tell us that it has been happening in spite of a downtrodden economy. Behavioral factors indicate that this is only the beginning. Collectively, these assessments suggest that continued growth is all but inevitable.
Admittedly, if the U.S. government fails to bridge the gap between parties during the first quarter of 2014, then we may see moderate pullback similar to the second quarter of 1934. However, times past tell us that a solution is unavoidable. Furthermore, if a long term agreement is put in place, fear of a Fed pull back should cease, and consumer confidence should continue to grow. Even in the event of failure though, one must remember that these are new and unusual times. Innovation and expectation are no longer an afterthought of subsidy stimulus and industrial strength. Times have changed.
The dot com boom made overnight millionaires an actuality. The Internet made information instantaneous. Social Media somehow manages to make instantaneous seem slow. Reality television has proven that celebrities can be created by nothing more than chance. This is the world we live in. This is the new reality. The once prized values of patience, hard work, and loyalty have been replaced by instant gratification, opportunity, and unapologetic entitlement. Both the market and the labor force have changed as a result. This new world will not allow itself to be held back by anything; not the Fed, the politicians, common sense, or historical convention. The new world is relentlessly in pursuit of more money, more opportunity, and more adoration.
Remember the young woman mentioned earlier? The one that refused to wake up in the morning for less than six figures annually. She never found a job. She didn't have to. When she couldn't get exactly what she wanted, she went out and created it instead. She opened up a designer clothing boutique for kids in South Florida. Currently she is comfortably exceeding her income ambitions. She invests in the market aggressively, and produces a web-based video series on the customers who frequent her store. That type of development would have been unthinkable just 20 years ago. This young woman is the poster child for the new world, the new economy, and the new work force. People like her represent why this bull run will not end in 2013.
I forecast a strong 2014. We may see, as mentioned herein, a slight pull back in the middle of the year pending political stagnation, but it would be a bump in the road. This continued growth should last in U.S. markets into late 2015, and early 2016. By then, improved conditions in Western Europe, growing economies in Latin and South America, and continued rebuilding in Asia will reclaim their share of investment interest. However, even the redistribution of investment in other regions by that time won't derail U.S. growth to a significant degree. This new age economy is here to stay. Innovation, voracity, ambition, and persistence will be the tent poles of this new market foundation. The next ten years are going to reshape and redefine our understanding of a market economy, and it's going to be a profitable undertaking.