I spend the fourth quarter of every year dissecting and forming my forecasts for the next calendar year. Over the past decade, it has been my experience that a solid top-down investment approach provides the lowest risk for possible returns. With that foremost in our minds, and a heavy economics bias towards investing, what can we expect in 2014? To be more specific for the purpose of not diverting our focus because of tangents, we will first look at the macro-economic view. With a thorough understanding of the macro-economic view, we will be able to decipher which sectors, industries, and individual stocks represent the best opportunities for profit in 2014.
World View: Taking too broad of a world view can be misleading, and doing so may skew our results and projections as well. Conversely, if we zero in on troubled or thriving nations we will endure the same fate. The key is to take a true temperature of the world economy. To put this dissection into the simplest of terms, look at developed and developing nations as a whole.
The developed nations (the United States, China, Germany, England, etc.) have decidedly turned around in 2013. Any analysts or "expert" opinions claiming that there is a market bubble is strictly an alarmist response to their own trailing performance, consequently attempting to justify that poor performance. While equity markets have more than recovered over the course of 2013, those rallies have occurred due to the cheap money available worldwide. Low interest rates available by nearly every developed nation have pushed anyone looking for a reasonable return into equity markets. Investors who stayed in precious metals, gold, or bonds lagged the market all year (exclude Bitcoin as it hardly shows signs of a "stable" investment).
Developing nations, even lump Greece into this category if you like, are becoming safer investments. Some could argue that developing nations and emerging markets represent the greatest opportunity next year as high growth opportunities are more bountiful in these arenas. A look at the ADR of the National Bank of Greece (NBG) over the past several months presents a microcosm of the rebounding nature of the world economy in general. The threat of another major financial meltdown has waned dramatically, and the recovery story is in full swing. The US GDP release on Thursday was an excellent illustration of that, as GDP came in at 3.6% versus expectations for a mere 2.8%. That follows an April-June period that showed an increase in GDP of 2.5%.
To decide between developed nations or developing nations for your portfolio in 2014 is more dependent on risk tolerance. The Eurozone will provide investors a phenomenal growth story, especially the southern nations of the Eurozone as they have the largest growth potential available after the debt crisis. However, there are still risks associated with those recoveries. Remember that recoveries are rarely achieved in a linear fashion, missteps should be expected. Whereas countries like the United States and China provide investors with a more secure outlook through an economic scope. US GDP is strengthening, employment numbers are increasing, and the equity markets have recovered substantially this year. Meanwhile, talks of a hard Chinese economic landing have almost entirely disappeared. In fact, China reported in October the strongest growth in GDP that they've had all year with a 7.8% increase in GDP. That begins the uptrend for China as they reported a 7.5% increase in GDP the three months prior. Put simply, world economies are strengthening and look to continue that trend through 2014.
Major Events to Come in 2014: Knowing that stability in the world economies has been restored, let us direct our attention to more domestic matters. The Federal Reserve and Congress will be a major factor in the equity markets throughout 2014. Neither of those bodies should be expected to have a positive impact on equity markets, although the Federal Reserve's actions should be looked at in a net positive manner.
The United States Congress is rumored to be nearing a two year budget deal to avert yet another government shutdown. However, we shouldn't pat those boys and girls on Capitol Hill on the back for finally playing well together just yet. The debt ceiling debate is sure to be yet another cluster, and that debate is set to begin with the start of the new year. Congress has only approved government funding through January 15th, with a deadline to reach a debt ceiling deal by February 7th. We can feel confident in expecting a knock-out drag-out fight yet again. This will definitely cause a pullback in markets as a US default threat looms.
We also have a Federal Reserve meeting concluding January 29th. Investors need to perk their ears as this meeting draws near. While the Fed meets again on December 17th and 18th, don't expect any major changes to Fed policy during an end of the year meeting. The Fed will most likely move to start curbing QE during the January meeting. Strengthening economic data, note our earlier mentions of US GDP and jobs data, will begin to apply pressure on long range inflation metrics with QE still in place in the current capacity. That will cause the Federal Reserve to begin tapering QE. Investors shouldn't be surprised if QE has concluded by the summer of 2014. Bear in mind, the end of QE signals a strong US economy moving forward.
The end of QE will cause the 10 and 30 year bond yields to increase as well. That natural move in yields will begin having an effect on the Fed's current target interest rate policy as well. Continuing improvement in economic data will force the Federal Reserve to start adjusting interest rates upward towards the end of 2014. Currently, the target Fed Funds Rate is 0 - 0.25%. A closer look at that Fed Funds Rate on a daily basis shows us that there is already a slow matriculation upward from 0.7 on October 31st to 0.9 as of December 4th. The combination of increased treasury yields and the end of QE will encourage banks to increase lending. Returns in equity markets won't be nearly as strong as 2013, as more conservative investors move out of stocks and into the increased yields in bonds. That cyclical shift will create a headwind for the equity markets, while providing banks further incentive to lend. That further incentive to lend will create an expansive environment for businesses, increase the inventory turnover rate in the housing market as buyers rush to beat the interest rate move up, and increase the velocity of money as well. Those factors will have a positive impact on consumer confidence, which will further help GDP and employment data. Even with the end of QE, inflationary pressures will persist. This will force the Federal Reserve's hand into raising the Fed Funds Rate. It isn't unreasonable to project the Fed Funds Rate to reach 0.75 to 1.00% by the end of 2014.
Projections: 2014 will have a myriad of headwinds for the equity markets for all the wrong reasons. Throughout 2013 the market pulled back if economic data became too strong, and the cheap easy money was feared to end. In 2014, the market will finally see what it feared all of 2013. The US economy will continue to strengthen, and the market will need to adjust to the new environment. 2014 won't be anything like 2013 in the equity markets when you could throw a dart at the board and find a winner. 2014 will require more skill, more discipline, and a better understanding of which sectors and industries are better positioned to thrive in a stronger economy with a rising interest rate environment. We'll discuss those industries and sectors in our next installment.
Additional disclosure: Investing involves a significant risk of loss, as such never invest more than you can afford to lose. Always consult with your registered financial professional before adding a new position to your portfolio.