Outlook for 2014
We don’t exercise discretion over the day-to-day investment decisions made by our Navigator engine, which incorporates all of our views of how best to position assets in differing market environments. However we do see value in occasionally pointing out to our clients notable macroeconomic conditions that we believe could portend a future change in market sentiment. Today we are in truly uncharted waters. Never before have equities experienced the sustained liquidity currently being injected into asset markets by the Federal Reserve. And although the QE1 taper that concluded in April 2010 was similar to the current QE3 taper, it occurred during a very different market environment in which equity valuations were generally much cheaper than today’s.
Borrowing Donald Rumsfeld’s notorious framework, equity markets are very good at quickly pricing the known knowns. They often anticipate the possible range of outcomes from known unknowns. It is the unkown unknowns that cause the most significant and persistent volatility. With that in mind we offer for your consideration some interesting data points, both bullish and bearish, for equities and for the economy.
Positive signs
In the minutes of its Oct 29th meeting, the Federal Reserve Board of Governors indicated it is likely to reduce the interest rate it pays on banks’ $2.5 trillion of excess reserves held at the central bank. Reducing this rate gives banks the incentive to put the money to work elsewhere, such as by lending it. This would be a much more powerful stimulant to the economy than quantitative easing.
Many confidence indicators rose steadily after the resolution of the government shutdown, including the Gallup Economic Confidence Index and the Conference Board’s Consumer Confidence Survey
In Q4 2013, The ISM’s Purchasing Managers’ Index rose to 56.2, the highest level since April 2011 and a co-incident indicator of economic expansion.
Several Federal Reserve measures of the economy indicate a benign environment that should be conducive to growth:
In 2013, Real Private Nonresidential Fixed Investment, a measure of business capital expenditures, exceeded levels last seen in 2008.
The Chicago Fed National Activity Index, a broad measure of the economy moved further into positive territory. This is generally indicative of accelerating economic growth.
The St. Louis Fed Financial Stress Index has returned to levels last seen in the mid-2000’s.
Also in Q4, we learned that U.S. home prices grew at their fastest rate in seven years, not seen since 2006, but with home prices on average still 17% below their 2006 peak. Rising home prices can contribute to the wealth effect and lead to increased consumer spending.
The consumer price index rose at a very low 0.3% annualized rate in December 2013, indicating that inflation pressures are not rising and therefore not threatening to interrupt the Federal Reserve’s accommodative Zero Interest Rate Policy. In November, the New York Times reported that similar low inflation rates prevail in the Eurozone as well.
Fund flows into U.S. stock mutual funds and ETFs turned positive in 2013 for the first time since the financial crisis. Fund inflows reached $76 billion in 2013, after fund outflows had peaked at $451 billion post-crisis.
Warning signals
According to Thomson Reuters, the Q4 2013 negative pre-announcement ratio is the highest on record. As of January 3rd 2014, 108 U.S. companies made negative pre-announcements, while 11 were positive. This continues a trend of higher than normal negative pre-announcements seen throughout 2013. To date this trend has not had a negative impact on U.S. equities.
Cisco’s final 2013 earnings call projected a surprising 8-10% revenue decline in 2014, due to a broad drop in orders from many emerging markets. CEO John Chambers said he’d never seen such a broad and deep decline before. While this phenomenon could be isolated to Cisco, Chambers said later on the call, “Most of my CEO counterparts can almost finish my sentences in terms of what’s occurring.”
The National Association of Realtors reports existing home sales declined in every month since July 2013, after rising earlier in the year. This coincides with the mid-year increase in mortgage interest rates. The NAR’s chief economist predicts the 30-year mortgage rate will rise to 5.5% by year-end 2014, from 3.5% in H1 2013.
In the past several months, the Chinese central government has wrestled to control shadow bank lending by increasing interbank interest rates. According to Fitch Ratings, China’s domestic debt has risen to 216% of GDP, up from 128% in 2008. Two separate liquidity crises have resulted – one in June 2013 and another this month – requiring emergency government infusions of liquidity.
At the end of 2013, the Investors’ Intelligence weekly survey of investment advisors recorded its most bullish reading since 1987 – more than 4 bulls to every bear. Such strongly bullish sentiment is generally considered a contrarian indicator, since it implies there are few investors remaining to enter the market.
Three prominent investors – Walt’s former colleague Byron Wien, Vice Chairman of Blackstone Advisory Partners, Bill Gross of Pimco, and Ray Dalio of Bridgewater - have all attributed 2013’s stock market performance primarily to central bank liquidity. Gross, in his December investment outlook, was particularly strident in his characterization of the policy: Many asset classes today “contain artificially priced assets based on artificially low interest rates… Investors are all playing the same dangerous game that depends on a near perpetual policy of cheap financing.”
Regardless of whether markets are more or less volatile in 2014 than in 2013, we remain committed to protecting and growing your assets.