David Joy: The state of the recovery: Positive but uneven heading into 2014

Despite the overhang of the upcoming Fed meeting, stocks in Europe and the U.S. rallied on Monday in response to firming manufacturing activity. In the Eurozone, the December Market manufacturing purchasing managers’ index (PMI) exceeded expectations by rising to its highest level since May 2011. It was the sixth straight month of expanding activity, and the third straight month of an accelerating pace of expansion. Germany showed particular strength.

In the U.S., the Market flash preliminary manufacturing PMI for December also showed another strong month of expansion, although the pace moderated slightly from November.

November’s industrial production report was also stronger than expected, particularly the manufacturing component which accounts for 75% of the total. In China, manufacturing in December followed a similar pattern to the U.S., as it expanded but at a slower pace from the prior month, although stocks fell on that news.

Taken together, these reports support the view that a global expansion, albeit one that remains uneven and fragile, is underway. And although, according to Bloomberg, the odds of the Fed announcing the commencement of QE tapering on Wednesday are just one in three, these reports do nothing to dissuade them should they be so inclined.

Bonds remain steady

Bonds seem little fazed by either the strength of the data or the prospect of tapering. The yield on the U.S. ten-year Treasury note, currently hovering near 2.86%, has barely budged in the past week and a half. The same is true in Germany, where the ten-year yield has actually drifted lower in recent trading, to a yield of 1.83%.

Of course, inflation remains subdued, and the idea of imminent tapering doesn’t seem as scary the second time around, after the false alarm in September. Nevertheless, it would seem likely that rates will push higher, particularly in the U.S., as the Fed eventually does diminish its buying demand for bonds, and as the economy accelerates.

The ongoing withdrawal from bond funds by individual investors further reinforces this notion. The Investment Company Institute reported the sixth straight month of bond fund outflows in November, and a continuation of the trend into the first week in December.

Temperate enthusiasm for the budget deal

The budget agreement announced in Washington last week has also removed the risk of another round of brinksmanship and a possible government shutdown in January. It still needs to pass in the Senate, where a relatively slim margin of victory is expected.

It is difficult to find anyone who is completely satisfied with the elements of the deal, or who is encouraged that it represents the dawning of a new era of bipartisan cooperation in Washington. But with the possible exception of extremists in both parties, most welcome the proposal. The country at present holds Washington in such low esteem, neither party nor the White House has a reservoir of political goodwill upon which to draw should another impasse arise.

Forecasting 2014

This being the end of the year, it is the season for making forecasts for the year ahead. In some sense, the business of forecasting has been devalued by the persistence of revisions. It seems to matter little how close to the actual year-end result one’s initial forecast is, since they are repeatedly adjusted in response to actual results as the year unfolds.

We would all be a lot wealthier if Las Vegas bookmaking operators allowed us to change our bets after each quarter of a football game. Nevertheless, as long as they are not valued in excess of the paper upon which they are written, forecasting can be a fun parlor game.

But whether they can provide a meaningful guide to the year ahead is debatable. Sophisticated models are constructed on the basis of past experience and a range of future expectations. Unfortunately, reality has a way of intervening, often with little regard for expectations.

 In that spirit, I will divulge my own 2014 forecast on Dec. 23, right after my final revision for 2013.

Disclosure

The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Ameriprise Financial associates or affiliates. Actual investments or investment decisions made by Ameriprise Financial and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance.

The S&P 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill.

The Eurozone Manufacturing PMI® (Purchasing Managers' Index®) is produced by Markit and is based on original survey data collected from a representative panel of around 3,000 manufacturing firms. National data are included for Germany, France, Italy, Spain, the Netherlands, Austria, the Republic of Ireland and Greece. These countries together account for an estimated 90% of Eurozone manufacturing activity.

The U.S. Flash Preliminary Purchasing Managers’ Index™ (PMI™) is produced by Markit and is a composite index based on five of the individual indexes with the following weights: New Orders – 0.3, Output – 0.25, Employment – 0.2, Suppliers’ Delivery Times – 0.15, Stocks of Items Purchased – 0.1, with the Delivery Times Index inverted so that it moves in a comparable direction.

Investment products are not federally or FDIC-insured, are not deposits or obligations of, or guaranteed by any financial institution and involve investment risks including possible loss of principal and fluctuation in value.

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