The Surprises of 2014

Images - Market Notebook - 140131 - Surprises of 2014Once again Bob Reiser, Senior Advisor on our Investment Strategy Team, has prepared a list of “forecasts.” As in previous years, the views expressed herein are solely those of Bob Reiser’s and may not be shared by other members of the Investment Strategy Team.

This is the fourth year that I have prepared a list of “forecasts,” and each year as I review the prior year’s forecasts I become more humble. My hubris was high when I did the first forecast in 2011, and I titled the piece “The Expected Unexpected for 2011,” implying I could forecast what others did not see. Three years of forecasts show how cloudy crystal balls can be.

But forecasts can be useful, even necessary as we plan our lives — vacations, income, family affairs, investment returns and more. The irony of forecasting investment returns is that the longer your forecast is, the more accurate you will be. For that reason I recommend reading Balentine’s 2014 Capital Markets Forecast, which has a very credible record of forecasting.[1]

Since I have demonstrated by my past forecasts that there is a high degree of uncertainty in the outcomes, for 2014 I will start with the consensus forecasts reflected by Wall Street and note where results may differ. Also, I am going to separate my comments between those that pertain to “Main Street,” what affects us as individuals, and “Wall Street,” what affects us as investors.

Main Street

  • Improving economy led by manufacturing and corporate investment;
  • Declining unemployment;
  • Favorable energy prices;
  • Stronger dollar;
  • Less political posturing;
  • No change in control of Congress;
  • Positive outcome for Affordable Care Act;
  • Continuation of current Federal Reserve policies.

Wall Street

  • Good U.S. stock market with probability of interim correction;
  • Rising interest rates;
  • Higher corporate profits but slower growth;
  • European recovery, albeit slowly;
  • Nervousness about the emerging markets.

The first word that comes to my mind in thinking about 2014 is uncertainty, not because it is a forecast but because we are seeing the rise of what I call “People Power.” Fueled by environmental challenges and geopolitical conflicts, this movement typically exists in countries with weakening economies. People Power is the population of a country feeling empowered to resist efforts to restrict their freedoms as the Internet shows what is possible around the world.  People Power is seen across the globe in a long list of locations:

  • Turkey:  protests against government corruption;
  • Egypt:  protests against government autocracy;
  • Bangladesh:  protests against voter fraud;
  • Thailand:  protests against government fraud and corruption;
  • Argentina:  protests against government economic policies;
  • France: protests against government spending priorities (no protests against Presidential infidelities);
  • Ukraine:  Protests against government policies.

Environmental issues have done nothing but increase over the past decade. The list is long and growing. Many of the issues are weather related and can be summarized as more extremes: more arctic cyclones, more coastal flooding, more hurricanes, more ocean warming and increased acidity. Humans have added their own environmental uncertainties such as the impact from gas fracking and oil drilling and, more recently, the risks associated with the transportation of energy (oil and gas pipelines and the recent rail crashes in North Dakota and Quebec.) As we have seen in Atlanta during the end of January, the weather is not always stable, but the current level of instability is unprecedented.

Finally, we have the geopolitical uncertainties, which arise mostly from government policies with cross-purpose agendas. An interconnected world is a more contentious world, as trade and migration issues are eclipsed by security concerns and the changing leverage of the players; for example, a stronger China and a weaker Japan. Today, geopolitical issues are exacerbated by security issues from terrorists and the economic needs of countries, particularly revolving around the control of natural resources.

How do these trends affect the consensus forecasts we reviewed earlier?

Main Street: The consensus may not be too far off, but the risks are on the downside. Weaker overseas economies and a stronger dollar may affect U.S. exports, thus slowing our economic recovery in consumer spending and housing. Such a development would certainly reinforce the Fed’s easy money policies. Energy prices look to remain favorable as U.S. production continues to rise.

Wall Street: After five years of a rising stock market, Wall Street is due a correction.  In fact, since 1929 (the earliest we have S&P data), there has been only one winning streak longer than five years (1982-1989). Using the history of the Dow Jones Index, there were none from 1896 to 1929. January has certainly gotten off to a lousy start, with the market down 4 percent from the beginning of the year to January 29.  A typical correction would be between 15-20 percent, which would bring market valuations more in line with longer-term average values[2]. The correction now going on in emerging markets is fueled by a variety of issues: declining commodity prices in some countries (Argentina being a prime example), the breaking of some bubbles in others (China’s housing market) and the general weakness of world economic growth. As a result, opportunities in many emerging markets may become very compelling this year. The consensus for Wall Street expectations are less certain than for Main Street, suggesting a divergence in results with a better U.S. economy and a poorer stock market.

[1] In 2013, we examined actual results against projections, employing a measure of volatility to quantify the reliability of the projections. The results show that for each time period the actual returns were well within one standard deviation of our forecasted returns. Furthermore, the actual results generally fell within one-quarter of one standard deviation of the forecast.  Statistically, this level of accuracy should only occur 22% of the time, or once every five years, but Balentine was able to achieve this precision in every period.

[2] For more, see “The Market Valuation Debate” in our 2014 Capital Markets Forecast.

Share this:
Tagged , , , , .