Permanent Value

Week in Review 1/6/14

Bruce Doole
January 6th, 2014

Market Perspective 2014

Where we’re going

We are seeing some developments that we think will help contribute to a still-positive equity environment in 2014.

Heading into the New Year, economic growth appears to be gaining some traction. Jobless claims continue to head lower (although seasonality issues does provide for volatility in individual readings), while the past couple of jobs reports have been strong, with October’s and November’s gains of over 200,000 each month. In addition, the unemployment rate dipped to 7.0%, the lowest level since November 2008.

We’ve also seen a pickup in the Baltic Dry Index (an index of global shipping rates), which tends to be a good indicator of global economic growth, after a pullback earlier in the year.

We believe the first part of 2014 will see a continued upward trend in US equities, although we will likely see some pullbacks along the way, with another debt deadline looming. There is a glimmer of hope around political dysfunction with the recent budget agreement; albeit not anything resembling a “grand bargain.” Additionally, Fed tapering will continue to be on the minds of investors, but low inflation puts little pressure on Fed to act aggressively and gives it increased flexibility.

Global growth to improve, despite regional divergences

Adding to the likelihood of a less aggressive US Fed, global growth is expected to strengthen in 2014, with the most recent OECD leading indicator and new orders in the global manufacturing PMI hitting multi-year highs, and pointing to an improvement in most major economies. The International Monetary Fund (IMF) is forecasting global growth of 3.6% in 2014, an improvement over the estimate of 2.9% for 2013 and 3.2% in 2012.

Europe less chaotic

Europe improved dramatically this past year, thanks in large part to ECB President Draghi’s “do whatever it takes” pledge, and the subsequent conditional bond purchase program that provided a safety net, restored confidence and thawed credit markets. Additionally, the fiscal drag in Europe decreased and labor reforms improved competitiveness in Spain, Portugal and Ireland.

As a result, Europe emerged from recession in 2013, defying the bears. Europe’s outlook for 2014 is subdued however, as there are obstacles to growth. The modest recovery has yet to become self-reinforcing to the upside, and the longer growth is suppressed, the risk is that prices, and therefore profits, begin to fall, which can become self-reinforcing on the downside. Already, eurozone inflation of 0.7% in October was low enough that the ECB felt compelled to cut rates and prompted bears to discuss the possibility that deflation in the eurozone could turn the region into the next Japan. We note that inflation is not a leading indicator, and if the economic recovery continues as we expect, inflation could pick up in the future.

The euro’s strength has confounded traders and is another risk for the eurozone. While the reasons for the strength are complicated, we believe the next move for the euro is lower relative to the US dollar. The Fed taper is likely to lift the US dollar and we believe the ECB needs to ease further to keep the economic recovery in motion. The decline in the ECB’s balance sheet and reduction in bank lending means eurozone financial conditions are tightening—an obstacle to growth. However, the next step for the ECB is likely to be more complicated, and could cause volatility in both the euro and eurozone stock markets.

We remain positive on European stocks because valuations are low and profit margins are depressed (and possibly at an inflection point); but there could be volatility in the first half of 2014 related to whether and how the ECB eases further.

So what?

In 2013 we saw investors move somewhat reluctantly into equities, and we believe there is more cash to be put to work in 2014. Investors should heed the lesson that there is no perfect time to invest, and often the times when it feels least compelling ultimately prove to be the most profitable. We expect the US market to experience a decent pullback at some point during 2014, but still believe stocks will end the year higher. Treasury yields will also likely continue to move higher, but not substantially so; with a 3-3.50% range seeming reasonable to us for the 10-year Treasury. European equities look attractive, and we are warming to the Chinese market, but Japan faces some critical events that we will be watching closely, while emerging markets ex-China still look unattractive. As always, keep a longer-term perspective in mind, as 2014 is bound to have both ups and downs that will require discipline in your investing strategy.

This Week’s Economic Data

  • Weekly jobless claims were little changed, down 2,000 to 339,000.
  • ISM manufacturing index held steady at 57.0 in December versus 57.3 in November


Source: Charles Schwab/Ivy Funds