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Will the Stock Market Soar Some More?

Published
December 15, 2013
Publication
Bottom Line Personal
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Allen Sinai, PhD
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2014 forecast from Allen Sinai, PhD

The bull market that began in March 2009 has survived steep unemployment…slow US economic growth…a series of fiscal cliffs…a European debt crisis…Middle East upheaval…and a slowdown in China’s economic growth.

But can the stock market continue to thrive into a sixth year and rise in 2014?

Can it overcome an expected rise in interest rates and the continued political warring in Washington, DC?

Top economist and regular Bottom Line/Personal contributor Allen Sinai says “yes.” He predicts that stocks, which have returned more than 180% since the market bottomed in 2009, will rise another 13% to 15% in 2014.

Here’s why Sinai is confident despite the formidable challenges ahead—and what it means for your investments…

PROFITS VS. POLITICAL ANTICS

The same conditions that propelled the stock market upward since 2009 remain largely in place. The economy is growing at a slow pace with very little inflation. Household wealth is increasing. Consumers are better off. Companies have learned how to be profitable even in a slow-growing economy, and their balance sheets show record amounts of cash.

sinaiforecast2014But the optimism is tempered by the endless political dysfunction ­emanating from Washington. Throughout 2013, Congress created a drag on economic growth and raised anxiety among businesses and consumers with its draconian budget cuts known as ­sequestration and the recent government shutdown. That shutdown and the threat that the US would default on its bills likely shaved up to one-quarter percentage point off economic growth for the second half of 2013, which I think will cause the year to end with an anemic annual gain in US gross domestic product (GDP) of just 1.8%.

There’s more political brinkmanship ahead in 2014. By January 15, Congress needs a deal to continue funding the government and avoid another shutdown.

A few weeks later, on February 7, it needs to again extend the nation’s borrowing authority. Congress also has been trying to tweak the sequestration formula before billions of dollars in additional heavy-handed budget cuts take effect.

A deadlock over these issues could harm the economy, hurt corporate profits and drive up long-term interest rates. But despite all the manic ­maneuvering, I don’t expect another government shutdown, because members of Congress face midterm elections in 2014 and don’t want to further anger voters.

The one positive note for investors in all this chaos is that the disruption to the economy has influenced the Federal Reserve to keep its massive economic stimulus program intact. It has continued to pump $85 billion a month into the economy through purchases of Treasury and mortgage-backed securities, and that has kept interest rates down and stock prices up.

Everyone has been speculating about when the Fed might begin to slow down, or “taper,” its monthly purchases. Given recent conditions, I expect a slow phaseout of the stimulus program to begin by next spring. Much of the stock market’s performance and volatility in the second half of next year could depend on the exact timing and magnitude of the phaseout.

The underlying fundamentals of the economy and strength of corporate earnings will continue to hold up. I do not expect the Fed to raise short-term interest rates at all in 2014—such a move would jam a wrench into the equity bull market.

Those rates have been at a historic low between 0% and 0.25% since December 2008 and likely won’t rise until early-to-mid 2015. The Fed has said that it does not plan to take such action until the unemployment rate drops below 6.5% and/or the inflation rate rises to 2.5% or higher.

KEY ECONOMIC MEASURES

Here’s what to expect for 2014…

    • Economic growth: GDP for the US likely will rise by 2.8% in 2014. That’s still less than the pace one would expect at this point in the economic expansion, but it is an improvement from the subpar growth rates of recent years. This forecast is based on two major factors. First, consumers will spend more aggressively because more will have jobs and many already feel wealthier, thanks to higher stock prices and home prices. Second, US exporters and manufacturers will benefit from economic recoveries in Japan and Europe. Globally, I expect inflation-adjusted GDP to gain 3.3% in 2014, up from about 2.5% in 2013.
    • Inflation: As measured by the Consumer Price Index (including food and energy), inflation will remain tame at a rate of about 1.5% in 2014, somewhat higher than 2013.
    • Unemployment: Job growth will show more vigor as 2014 progresses. I expect the US to add about 180,000 jobs a month as the unemployment rate drops to 6.3% by the end of the year, compared with 7.3% in October 2013.
    • Real estate: The housing market, a main driver of the economy now, will continue its healthy recovery despite the recent temporary weakness that resulted from higher mortgage interest rates.

The interest rate on 30-year fixed-rate mortgages likely will hit 4.8% by the end of 2014, compared with 4.16% in early November 2013. Despite that, home prices should advance by nearly 10% in 2014 as banks relax lending standards, inventory levels remain low relative to what we have seen in the past and buyers take advantage of rates that still are historically very low. However, price appreciation will be distributed quite unevenly across the country, with certain areas, such as Arizona and California, much stronger than others.

STOCKS

Stocks should do well next year, driven by better corporate earnings, which I expect to rise by 8% to 10%. But even if stocks emerge unscathed by the actions in Washington, DC, they are unlikely to repeat the robust gains of 2012 and 2013, simply because valuations are higher. The S&P 500 is reasonably priced now but no longer cheap, with its component companies trading at an average of 18 times earnings for the past 12 months. That’s higher than the historical average of 16.

The Standard & Poor’s 500 stock index should continue to hit all-time highs, advancing about 13% to 15% for 2014 and approaching 2,000 by year-end. The Dow Jones Industrial Average will have a similar percentage gain—to near 18,000.

Best areas of the stock market now…

  • Consumer discretionary. Companies in the automotive…leisure and hospitality…consumer finance…and Internet-retailing ­sectors—which have led the stock market rally this year—will benefit from more vigorous consumer spending in 2014.
  • Consumer staples. The stocks of large businesses that sell essential products such as food, beverages and household items should outperform the overall market and surprise investors, mostly because global growth and exports will work in their favor next year.
  • Foreign stocks. The Japanese Nikkei Index has gained about 40% in 2013 as of November 8. I believe this is the beginning of a strong multiyear rally as the Japanese government and the Bank of Japan take the most aggressive steps of the past two decades to jump-start that economy. European stocks, up 16% as of November 8, based on the Stoxx Europe 600 index, resemble the US market in 2009, combining cheap valuations with a slowly improving economy and ultra-low interest rates. European markets could see strong gains for several years.

BONDS

The bond market, including corporate and government bonds, will have another disappointing year in terms of total return. Expect low single-digit returns at best as investors continue to find the stock market a more attractive place to put money. The steadily improving economy will help push up long-term interest rates, and the 10-year US Treasury yield—recently 2.7%—should be in the range of 3.25% to 3.5% by year-end. However, if Congress fails to extend the debt ceiling, the US will see its credit rating lowered and spooked investors could push Treasury yields up and the prices of most bonds down. Therefore, if you do hold bonds, it is more vital than ever to protect yourself from losses by keeping their maturities at short-to-intermediate term lengths.