Grand Street Advisors
Market Outlook
2014
“Lions
and Tigers and Bears oh My”. Dorothy traipsed a path
towards OZ fearful as an ant at the wrong end of an aardvark.
Similarly, many investors and prospective investors eyed the equity markets all
through 2013. Ultimately their fears of Legal and regulatory
reform Tapering of the Federal Reserve Monetary stimuli and Budget
shortfalls were all overcome by an improving job front, resilient consumer and
impotent office holders in DC. The US economy is clearly
gaining momentum after having risen 4.1% GDP in the third quarter and
economists on average looking for continued economic expansion of 2.6% in the
just concluded fourth quarter.
To
The Stats:
Jobs: Non-Farm
payrolls continued to surprise Wall Street economists and investors all
year. Payroll figures have entered a level often referred to as being in
the Goldilocks Sweet Spot. Not too hot, to force the Federal Reserve to
alter policy and raise interest rates. Not too cold as to force the
Federal Reserve to take even more drastic and possibly inflationary measures to
spark growth. We seemed to have entered the Just Right point which will
allow the Federal Reserve to neither raise not cut interest rates but allow
them to initiate the downsizing of their monthly asset purchase program
beginning in January. November Non-Farm payrolls came in at a strong
203,000 with many forecasters looking for a more tame 165,000. This
put the 12 month average just shy of 200,000 at 195,000. While still not
great, much improved.
Chicago
Purchasing Managers Index (CPMI): CPMI which has a good predictive
history for the National figures slipped to 59.1 from 63 which stood at a 2yr
high. While there was some weakness some can be attributable to year end
and a big drop in inventories. This may sound really bad but taken
in the appropriate context it was really quite positive. The big spike in
the 3rd quarter GDP figure was driven by huge inventory
builds. There were fears among some that the consumer would not show this
holiday season leaving retail shelves overstocked leading to a drag on growth
in 1st quarter productivity. This large drawdown clearly
suggest this did not occur and we instead should look forward to a restocking
cycle that must commence.
Housing: The housing
recovery is in full gear. New home sales for November came in at a
seasonally annual adjusted 464,000 which was a solid 16.6% over last
November. The average sales prices was $340,000.00. The amount of
homes available for sale stands at 4.3 month supply at current pace.
Total existing home sales came in at a seasonally adjusted annual
rate of 4.90 million which was down 1.2% from November 2012. The
figures were impacted by the spike off generationally low interest rates, tight
supplies of homes for sale and continued tight underwriting standards.
Said NAR Chief Economist Larry Yun, “There remain pent up demand
for both rental and owner occupied housing as housing formation will burst out
but the bottleneck lie in supply. As such rents are rising at the fastest
pace in 5 years”. Aside from housing being reflective of consumer
sentiment and confidence housing is very supportive of the overall
economy. Specifically through construction jobs. Also people
who purchase homes tend to purchase new appliances, paint, furniture etc.
which creates even more jobs and consumers completing a cycle leading to a
self-sustaining recovery.
Consumer
Price Index (CPI).
CPI was unchanged in November which would translate to a +1.2% increase year
over year. Inflationary pressures should remain muted due to the slack in
Capacity Utilization and an underutilized work force and below historical
inflationary wage growth. The trailing twelve month core figure (ex food
and energy) came out at 1.7% still below the Federal Reserve inflation target
of 2%.
Federal
Reserve Policy:
The Federal Reserve and specifically Chairman Bernanke has been a most
prescient Market Maestro plucking our strings in such rhythm as to sooth our
fears of The Great Taper. Chairman Bernanke assured investors
frequently and persuasively enough to the point where instead of a market route
the market actually rallied almost three hundred points upon announcement of a
$10 billion cut in stimuli beginning in January. The Great B-Oz I
asserted the $10 billion cut in Quantitative Easing was not a change in
policy and their -0- interest rate policy would proceed into 2015 if not
2016. I don’t where he gets his pixie dust but I want some.
Going
Forward:
The
global economy is in much better shape entering 2014 from twelve months
ago. The Euro-zone has stabilized and is anticipated to expand +1% as
measured by GDP vs. the -.4 contraction in 2013. China, while
having slowed from the double digit economic expansion rates of years gone by,
appears to be targeting and executing growth in the range of 7 ¼%-7 ¾%.
The spillover effects for their Asian neighbors should reflect positively for
Japan, South Korea, Indonesia, Philippines and Vietnam among others.
The
fears that restrained investor enthusiasm in 2013 have not disappeared.
The dysfunction in DC allowed our elected brain trust to merely kick the can
down the road when it came to budget negotiations. Importantly for them
past the midterm elections. At a minimum we’ve obtained a
degree of certainty surrounding policy and taxes which should unleash some much
needed capital outlays for equipment, IT upgrades and headcount
expansion. This should add ammunition to the argument that we’ve finally
reached breakaway velocity from the recessionary pressures of ‘08’-09. leading
to growth accelerating closer to 3% in 2014. There remain much that
can go wrong which leads to a healthy amount of pessimism keeping investor
enthusiasm in check. Which leads us to our Black Condors for 2014:
Interest
Rates.
The improvement in the economy and the markets is due in no small fact to
generationally low level of interest rates. As the economy improves,
borrowing should pick up and interest rates will rise. The Federal
Reserve will alter their monthly asset purchases by $10 billion beginning in
January. There should be no fears of rising rates any rise in
rates is a reflection of growth and demand. Interest rates and
borrowing costs can be managed and hedged. It really is the velocity with
which rates rise as seen in August when the Fed first mentioned Tapering.
Rates spiked and the market hiccupped. If rates spike quickly to the 3
1/2%-3 ¾% range expect to see the bears reengage the markets and a correction
of 8%-10% may follow.
Fiscal
Policy.
Or lack of one. House Speaker Boehner finally found his backbone and
lambasted the extreme right of his party for their scorched earth policy or
“just say No!” policy. The time for negotiation is upon us for a
balanced budget, reforming safety net programs Social Security and Medicare
along with Immigration policies. Should Boehner be overrun by the
far right expect the level of fiscal uncertainty to spike and the market to
possibly correct 10%.
Iran’s
No Nukes.
Goes up in smoke. President Obama is gambling on a grand compromise with
Iran to compliment his retreat from two grueling wars and the hotbed of unrest
in Libya, Syria, Egypt and a simmering Turkey. Should Iran be just
biding time and ultimately pull back from Western negotiations and demands
expect to see a spike in tensions along with energy prices amid threats of
renewed military consequences.
Japan
default-
Shinzo Abe’s bold moves to stimulate Japan’s economy have spurred the market
and economy to decades highs. Recent reported data show a slight
slowdown in economic activity. Should this weakness persist and
investors lose confidence and pull out the fallout could be catastrophic.
The global economy shuddered with the potential collapse of postage sized
Cyprus, a country with a bit less the $20 billion in debt. The effect of
a Japanese debt default on $6 trillion in debt would make the Lehman
bankruptcy look like a neighbor bouncing a check at the local grocer.
We
project S&P 500 earnings of $128 per share which is at the upper band of
Wall Street analysts range of $118-$133. Using a reasonable
historic price earnings multiple of 16-16.5 brings us to our year-end target
range of 2048-2112 or 11%-14% gains. The primary risks we see to our
opinion are 1. The handover of power to Janet Yellen at the Federal Reserve.
2.Political dysfunction reemerging in DC and 3. The strength of the
economy. We may just be underestimating the upside potential to
earnings and the markets should one and two not pan out which should finally
see investors reengaging in the five year old bull market.
Thank
you again for your confidence in these very challenging times.
Yours
in pursuit of the KWAN!
James
