Can reality keep up with hope in 2014? «
The stock market gains in 2013 were largely fueled by hope that 2014’s economy would accelerate. The anticipation was that employment numbers would continue to improve, the global economy would pickup and corporate earnings would keep chugging along. That hope — and likely desperation from those who had been out of the stock market since 2009 — led to retail investors pumping the most money into stock funds since 2000.
The problem with the hope is that it is largely speculative and based upon ignorance of what is really ailing the world economy.
As I discussed in a quarterly letter in October 2010, as well as, on MarketWatch in November 2012 and September 2013, the United States is in a demographically driven depression. Japan, Europe and China are also in bad demographic spots, and in fact, are worse off than America. At least in the U.S., we have the “echo boomers” or “millenials,” which is as big as the baby-boomer generation, hitting the workforce now and starting household formation.
Around the globe, while we know billions want a better standard of living, economic development is at best uneven. Better development is necessary to justify the hope that the 2013 stock-market rally was based upon.
Back in America, employment numbers for December were woefully disappointing. Despite a 6.7% unemployment rate, the number of people working in America is about three million fewer in January 2013 than January 2008, despite a slightly higher population. Today, the labor participation rate is the lowest in a generation.
In 2014, we know that the Federal Reserve will at least attempt to slow down on easy-money policies. They are attempting to pull back on quantitative easing for two reasons. The first reason is to avoid a negative consequence. As Pimco’s Bill Gross wrote:
“The Fed will have to taper, cease and then desist someday. They can’t just keep adding one trillion dollars to their balance sheet without something negative happening…”
The second reason the Fed is trying to reduce the growth in their balance sheet is that they hope the economy is firming up in way that they feel makes continued easy money less necessary. If the economy is, in fact, on the cusp of organic growth, then the Fed can claim victory for their policies and move on to a more normal stance over the next few years.
Interestingly, while I agree with Gross, I also believe that the new Federal Reserve Chair thinks the Fed can continue with quantitative easing at some level for years, yet without that feared negative consequence occurring. If there are any hiccups in the economy, Janet Yellen, based up on her confirmation testimony, will likely maintain easy-money policies.
Yellen’s set of “what ifs” which I discussed in a recent article, are substantial. What we as investors must keep an eye on is where exactly the Fed puts the most importance, avoiding a negative consequence of easy money or avoiding a negative consequence of another deflationary period in the economy and markets. The IMF and World Bank both warned about deflationary pressures still in the world within the past week.
As we stride into another earnings season, we are seeing weakness in quite a few companies, particularly in forecasts. Already we know that revenues and earnings growth are both flattening.
Companies face a very uncertain period right now. If they take the leap of faith and start hiring, they will see a slight fall in earnings. If they don’t hire, ultimately they are harming their own aggregate demand and revenue. It is a tangled web.
Predicting the next stock-market move is even more unpredictable than usual. If the Fed continues to taper, then a stronger dollar could very well cause a stock-market correction. In that case, investors will need to be willing to sell quickly if they’d like to avoid big losses. Should the Fed continue to provide easy money and taper more slowly, then investors will need to be able to access the growing parts of the market.
For investors who are looking for a strategy, being highly nimble is a must. Recently, parts of the market have exhibited signs of being overextended and exhausted. In our quantitatively driven tactical strategies, we recently sold dividend-paying stocks in the iShares Select Dividend ETF /quotes/zigman/335187/delayed/quotes/nls/dvy DVY +0.23% and the Schwab U.S. Dividend Equity ETF /quotes/zigman/7013936/delayed/quotes/nls/schd SCHD -0.50% — depending on custodian. We also lightened up on our S&P 500 holdings in the SPDR S&P 500 ETF /quotes/zigman/714403/delayed/quotes/nls/spy SPY -0.01% and iShares Core S&P 500 ETF /quotes/zigman/259938/delayed/quotes/nls/ivv IVV +0.38% once again, custodian dependent as we use the no transaction-charge ETFs whenever possible.
Right now, I am working with my top subadviser to build upon an existing five-star-managed ETF strategy. The new tactical strategy will add the ability to more fully take advantage of macro themes and secular trends, while offering protection from various global risks and a possibility of profit from certain negative events.