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It's too early to mean much, but so far out 2014 forecast is falling nicely into place. The market highs on Dec 31st have held, bonds are outperforming stocks, gold is outperforming both stocks and bonds, while gold mining shares are soaring! The anticipated volatility in emerging markets and Japan as well as the wild card of the Chinese economy continue to unfold, while bad weather has postponed the evidence of strong 2014 US growth.
Emerging markets were rattled by revelations of Chinese problems that coincided with weather related economic news from the US. While most emerging markets fell, only a few like Argentina and Turkey had genuine problems. The real threat to global growth continues to be the debt bubble in China. Given the government-controlled information flow, it is impossible to predict at what pace we will get evidence of deteriorating growth in the Middle Kingdom. When the storm clouds clear from the Midwest and East coast, rising US demand will more than offset slowing Chinese demand for most emerging market exporters. 2014 will be the year to invest in Emerging Markets (most non-Chinese), but there is no reason to believe we have seen the bottom yet.
Springtime will usher in US economic growth on the high side of market expectations. Banks desperate to replace revenues from disappearing mortgage refinance fees, proprietary trading profits, and favorable loan-loss adjustments will continue to lower lending standards and find willing borrowers. Until recently, Fed money printing failed to translate into easy credit for the real economy (mortgages excluded) and mostly just inflated the prices of stocks and bonds. Now that process is reversing. Money has started to flow into the real economy, creating jobs and boosting incomes. Recent weather-related data not withstanding, the Fed will not only continue to taper its support for the financial markets, but accelerate that process later in the year. Corporations will begin using their cash to make real investments rather than buy back their own stock.
Bonds have entered a secular bear market as the economy expands and the Fed withdraws support, but we continue to expect short-term bond rallies in response to periodic stock market declines. If you are going to own bonds for the rallies, maintaining liquidity is critical. Favor very high quality bond funds and avoid exposure to lesser credits that will move down in sympathy with lower stock prices. We would also recommend avoiding individual bonds because the cost of exiting them prior to maturity is likely prohibitive.
Over the course of the year, inflated US stock prices will be battered by both disappointing earnings and lower P/E ratios (driven by the rising interest rate trend) despite strong US growth. Earnings will be held back by the slowdown in China as well as rising payroll and investment expense, offsetting rising US corporate revenues. Despite the recent rally bringing stocks back near to their highs, it is enough to know that stock prices are headed significantly lower. Whether the decline takes the form of precipitous drops or ratchets its way down. We expect 18 months from now the US stock market will have given back all of the 2013 bubble gains and much more. We believe the best performing sector for 2013 will continue to be gold mining shares.
Chief Investment Officer
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4.15.13 - The Bernanke Illusion
3.15.13 - US Economic Outlook
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12.10.12 - Tax Reform: A First Step
9.17.12 - QE3
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3.12.12 - March Flash Update
2.23.12 - February Flash Update