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Health & Fitness

David Joy: 2014 Markets - What to watch for in the new year

The new year is upon us, as the first full week of trading gets underway. And notwithstanding the two down days with which stock trading began the year, the issues confronting investors are seemingly fewer, but no less important.

For one, the budget agreement reached in Congress in December has delivered relative fiscal peace and certainty, taking off the table the Jan. 15 deadline that otherwise would be a primary preoccupation and cause for worry.

Neither is there the worry over the impact of higher taxes that existed at this time last year in connection with the fiscal cliff, nor the impact of spending cuts in connection with sequestration several months later.

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The Fed’s decision to commence tapering in January, along with its forward guidance on interest rate policy, has eliminated monetary policy as a source of uncertainty, at least for now. The minutes from the Fed’s December meeting will be released on Wednesday, but we already know the outcome. It will be akin to reading a book whose ending we already know. Some of the detail will be interesting, but anticlimactic.

Labor, Housing and Manufacturing
These welcome developments will allow for a greater focus on fundamentals, but by themselves do not necessarily guarantee a benign outcome for investors in the year ahead. A number of questions remain.

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The U.S. economy is generally expected to perform somewhat better this year. Real growth in the range of 2.5-3.0% is widely anticipated. The Fed’s central tendency expectation for 2014 is 2.8-3.2%. The Federal Reserve Bank of Philadelphia’s Survey of Professional Forecasters, published at the end of November, anticipates 2.6% growth in 2014.

Meanwhile, the Conference Board’s latest reading on the index of leading indicators in November rose at the fastest pace since April, and according the press release, “…continues on a broad-based upward trend, suggesting gradually strengthening economic conditions through early 2014.” The December report will not be released until Jan. 23 but recent data suggests that the economy ended 2013 on a firm note.

A lot will depend on the health of the labor market. Enough improvement has been experienced to allow the Fed to begin to taper, but unemployment remains above the 6.5% threshold for the reconsideration of monetary policy.

The December employment report is scheduled for release on Friday, and the expectation is that 195,000 new non-farm jobs were created and the unemployment rate remained unchanged at 7.0%. How quickly a firmer economy pushes the unemployment rate toward 6.5% will influence expectations about the pace of tapering and the timing of the first increase in the overnight rate. That debate will most likely not intensify until well into the year’s second half, but could commence sooner if growth exceeds expectations.

Housing is another wildcard. Higher interest rates on mortgages don’t help. According to Freddie Mac, the average rate on a thirty-year fixed-rate mortgage rose to 4.53% in the week ended Jan. 2. This is roughly 40 basis points higher than the average rate in early November, and back to the levels that prevailed in late summer, which slowed activity and contributed to the Fed’s decision at the time to delay tapering.

The manufacturing sector has been strong recently. After briefly falling below the expansion/contraction level back in May, the manufacturing Purchasing Managers Index has strengthened significantly, before moderating slightly in December at a still healthy level. Continued growth in the sector will depend on the strength of the consumer, but also on the willingness of corporations to increase their own pace of investment, as well as the relative strength of the global economy. Some improvement is expected in both, but how much is uncertain.

Then there are the markets themselves. Despite finishing their best year since the late 1990s, stocks do not appear to be overvalued. Fully or fairly valued? Perhaps. But at 15.3x consensus 2014 earnings, especially in the current low inflationary environment, the S&P 500 does not seem out of line with historical levels. Of course, that presumes that expected earnings growth is achieved and inflation and interest rates remain relatively well behaved.

Fourth Quarter Earnings Get Underway
How Corporate America ended 2013 will begin to come into focus this week with the start of fourth quarter earnings season. According to Factset, earnings are expected to have grown 6.3% versus last year’s fourth quarter, a forecast which has been revised lower over the past three months from 9.6%, a decline for the quarter which is lower than the historical average. Lowered expectations for the energy sector are the primary culprit, while financials are anticipated to record the strongest growth.

The yield on the ten-year Treasury note currently resides at 2.96%. That is a little lower than the 3.02% rate at which it ended the year, but is still appreciably higher than the 1.90% rate at which it began 2013. By itself, a 3.00% rate is historically low, and a further modest and orderly rise from here, as many expect, would not appear to present too much of a problem for the economy, especially if inflation remains subdued.

But, as we have seen, there has been an impact on housing from the increase in mortgage rates that has already occurred. The Fed expects the core PCE inflation rate to rise in 2014 to a range of 1.4-1.6%, from 1.1-1.2% in 2013. The aforementioned Philadelphia Fed Survey of Professional Forecasters anticipates a 1.7% pace in 2014, up from 1.2%, and a year-end yield on the ten-year note of 3.20%. A recent Bloomberg survey anticipates the ten-year yield will end the year at 3.40%.

The influence of policy has receded, but the questions surrounding the pace of recovery remain. The outlook appears brighter, and most forecasters anticipate modestly positive gains in equities and slightly positive to slightly negative returns in bonds, depending upon the sector. Happy New Year!

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.

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