As
we mentioned in last week's article, we are providing our most current outlook on global
economic growth. We will update our projections periodically to reflect
our latest views.
Economic
indicators have been very confusing for investors. “Good news” about
economic growth has been perceived by the markets as “bad news”, as it could
lead to reduced monetary stimulus from the Federal Reserve. In this
article, we will identify some key economic information and separate each point
into good news and bad news, then come to a final consensus as to our specific
views about the economy and how it will impact stock market growth moving into
2014.
1. Slow
Economic Growth
Economic
growth in the United States has been mostly flat coming out of the recession in
2008-09. In the 2nd quarter of 2013, real GDP growth was a
mere 2.5%. The economy has been “muddling along” for quite some
time. We anticipate slow economic growth will continue into 2014.
The Bad: Slow economic growth is not good for employment and those seeking employment. Low demand for new workers puts very little upward pressure on employee wages. That means little-to-no increase in discretionary income for households, which impacts consumption.
The
Good: It is nearly impossible for inflationary pressure to build in an
environment where job growth and wages are stagnant. Muted inflation and
continued employment problems will drive the Fed towards continued economic
stimulus to satisfy their dual mandate of optimal inflation and employment.
2. Low
Interest Rates
The
Fed’s taper talks caused a spike in 10-year U.S. Treasury yields, which have
fallen over the past few months and settled down near 2.5%. Flat economic
growth and inflation will likely keep Fed stimulus unchanged until early 2014.
The
Bad: Interest rates are not likely to move higher
until we see economic activity above 3.0%.
The
Good: As the chart above shows, 30-year Mortgage rates have fallen below
4.5%. Lower mortgage rates means more
people can afford to buy a home or build a new one. The housing industry
is estimated to impact about 20% of the U.S. economy. The low cost of
borrowing is also very positive for other consumer expenditures (such as cars,
etc.) and business investment.
In
addition, we have said many times that “when
the dust clears” and the shouts about Fed tapering calm to a whisper, interest rates will remain in a range between 2.5% to 3.0%. Rates have fallen to
the lower end of that range, which poses no headwinds against stock prices moving
higher.
3. Falling
U.S. Dollar
According
to Yardeni Research, the trade-weighted dollar index has fallen to end-of-2009 lows. As the chart below
shows, the U.S. dollar is very low compared to where it has historically been.
The
Bad: For major foreign investors in U.S. bonds, the after-currency-adjusted
rates of return will be even less than the coupon rate. When major buyers
of U.S. bonds (countries like Saudi Arabia, China and Great Britain) start
seeing negative currency-adjusted returns, they may start complaining in the
media and initiating discussions about the U.S. letting their currency
slide.
The
Good: A falling dollar makes U.S. exports much more competitive in the
worldwide market, particularly in Europe and Asia. That could mean
positive earnings surprises in the 4th quarter of 2013 and 1st
quarter of 2014 for companies with significant exposure to other
countries. That is of particular interest to us, as 60% of the earnings
of the companies we own are produced outside the U.S.
4. Positive
Worldwide GDP
For
the first time since 2007, 4 of the world’s major economies (United States,
Europe, Japan and China) all have positive economic growth.
The
Bad: There can be nothing bad about this!
The
Good: At the very same time the U.S. dollar is getting cheaper, the global
economy is getting better, which is another indication that earnings for U.S.
corporations could surprise to the positive.
5. Falling
Oil Prices
Crude
oil has dropped below $100 per barrel, which has translated to a fall in gas
prices at the pump down to a U.S. average of $3.29 per gallon – down $0.27 from
a year ago.
The
Bad: One of the patches of strength in the U.S.
economy is the current boom in both oil and
natural gas. The companies in these
industries provide lots of quality, high-paying jobs. If oil
prices continue down, it would dampen earnings and potentially lead to reductions in employment. We don’t anticipate oil prices are going to fall
significantly. Should they, however, there would be increased talks about
the end of the oil boom.
The
Good: In our mind, oil and gas prices act like a tax. All consumers in
developed countries are getting a break as a result of the fall in oil prices, which
means more discretionary income, spending and modest improvements in the
economy.
6. U.S.
Government
It
is very clear that Americans did not like the Republicans' role in forcing the
government shutdown. It is equally clear that voters do not like how the roll out of Obamacare is progressing, or NOT progressing.
The
Bad: The Government shutdown highlights bigger issues in Washington.
Republicans and Democrats are very divided on major issues, which has
stalemated U.S. government function.
The
Good: In the entire Obama era, the Democrats and Republicans
have never been in a position where reaching some sort of agreement
has been so important to both government function and their political
lives. The only way they can get there
is through a softening from both party extremes.
While we don’t anticipate any major breakthroughs, we don’t expect either party will let another Government
shutdown happen during the next round of debates in February 2014.
7. Lots
of Cash
Savings
deposits have skyrocketed since 2008-09. Investors and corporations alike
are holding more cash now than ever before.
The
Bad: Cash sitting on the sidelines means there is a lot of money out there that
is not producing economic growth from investment into the stock market, small
businesses or entrepreneurial activity.
The
Good: Cash sitting on the sidelines also means the potential for investment is
very high. As interest rates continue to stay low, people are going to
get tired of earning nothing and start looking for places to put their money to work.
Outlook
for the Market
The
economic and political headwinds against the stock market are fading.
Positive GDP growth from major countries around the world will help boost
company earnings and create some earnings surprises. We expect the economy will continue to grow very slowly,
which will keep inflation and interest rates low.
Low interest rates mean
the abundance of cash earning very little interest will likely start moving
somewhere for return. With very little opportunity in bonds, there is
only one place left to go: the stock market.
