2013 was a stellar year for stocks as Fed bond buying kept interest rates low and propelled investors to seek yield in the stock market.  Economic growth improved steadily and government data (employment, debt levels and fiscal spending, housing prices, manufacturing) showed ongoing improvements.  Corporations recorded robust profits and consumers became more confident.

I wrote last January in Great Rotation Time that investors would begin favoring stocks over other investments.  What actually happened was this:  Investors remained cautious.  They were anxious about rising interest rates and departed bond funds, putting some of that money into stocks.  However, investors seemed to retain much of the outflow from bonds in cash.  Thus, a solid economy may act as a catalyst for investors, appetites whetted for more risk, to move cash into equities creating further gains in 2014. Equity funds have yet to make up for the massive outflows since the global financial crisis in 2008 through 2012, so when animal spirits return, look for larger mutual fund balances too.

Key indices’ annual return for 2013:

S&P 500                     32.4%

S&P 400 Mid Cap      33.5%

S&P 600 Small Cap   41.3%

I also note that the while investors continued to show a preference for growth stocks in 2013 (think large dividend paying companies with low volatility such as Health Care), the advantage over value stocks (think cyclical sectors such as Tech) narrowed to less than 1% compared to an almost 2.5% differential several years ago.  See S & P website for more information.

Coming up next in 2014? I’ll take normal, please!

With the US gross domestic product finally surpassing pre-recessionary levels, housing (See my Positive Feedback Loop and Housing), consumer sentiment and spending continue to approach historical levels.

Improvement in consumer net worth is driving retail sales.  And businesses are finally spending more.

Still to come are wage growth, improved hiring, and more equalization between businesses and employees which would give individuals more confidence to form new businesses, accept new opportunities and seek new challenges.  Some trends that I anticipate that may result in investable themes include:

  • Increases in employment opportunities for younger employees spurring household formation, which has been profoundly depressed in recent years.
  • Greater confidence among workers to change jobs.  The “quit” rate has increased over the last year according to the last employment report (next one is January 17th)
  • Look for increased mobility among workers as jobs become more plentiful.  The American Labor force, known as the most dynamic among developed economies, has stayed put for the last few years.
  • Productivity enhancements continuing to revolutionize how Americans work, spend their leisure time, and consume services  (Tech sector companies)
  • Rebound continuing in US manufacturing aided by plentiful energy supplies and a dynamic workforce (Industrials, Transports)
  • New economy versus old economy companies (think social media and internet services versus old media and brick and mortar businesses)

Potential headaches along the way

  • New Fed Chair Janet Yellen is known as “dovish” and a proponent of keeping stimulus going as long as necessary.  Nevertheless, renewed “Taper Tantrums” – when investors sell equities at hints of less bond buying – could happen again.
  • Look for potential volatility around the debt ceiling debate in late January/early February
  • Companies may continue to hold back hiring as the Affordable Care Act is implemented
  • The rise in political populism could create a drive to reform the tax code, another form of uncertainty that holds back confidence

2014 – A recovery worth waiting for

Many of the concerns I have listed are related to government and policy.  With the economy on a sustainable growth path, however, the impact of government spending (more by local governments, less by the Federal government) is less significant than in prior years.  After political dramas, the debt has now stabilized to 70% of gdp.  And in large part, the politicians can step back so the economy and markets may advance.



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