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2014 Market Outlook

2014 Market Outlook

Some Bumps along the Road of Global Recovery

Tapering was expected to begin in September/October 2013 but was delayed by the Federal Reserve (“Fed”) due to economic uncertainty and instability. Towards the end of 2013, the Fed announced, however, that they would begin tapering their bond buying by $10 billion to $75 billion a month starting in January and will continue to do so upon signs of an improving economy. We expect tapering will continue throughout 2014 and will likely be completed by the end of the year, recognizing that the Fed is scheduled to meet 8 times in 2014 as of this point in time.  After tapering, we anticipate bond sales (i.e. federal balance sheet reductions) beginning in early 2015 and the initial stages of a protracted and measured period of Federal Funds Target Rate increases during the second half of 2015.   In this regard, we believe that the Fed will follow a similar blueprint to the one they employed in 2004 – 2006 when they raised this key interest rate by 25 Basis Points (0.25%) on seventeen different occasions over this three year time period.

Volatility should return to the market during January-February due to likely heightened tensions and political discord in Washington over another strained round of debt ceiling talks and lingering investor concerns pertaining to current stock market levels. In our view, investors should look past the drama in Washington.  However, many investors may see this unrest as an opportunity to take some profits and move money out of the market during the first quarter. This may result in an initial trade down early in the year with a rally during the remainder of the year, defying the notorious “January Barometer” indicator*, as the economy continues to trudge positively forward at an annualized Gross Domestic Product (“GDP”) growth rate of <3%.

Bonds could stand to benefit from the early stock market volatility and are likely to hold firm for the balance of 2014 as we expect new Fed Chairman Janet Yellen and team to follow a very measured and transparent tapering process.

Overall, we expect a high, single-digit gain for the S&P 500 index overall in 2014.  With this said, we contend that U.S. stock market returns will likely be outpaced in 2014 by certain International – Developed Market returns, notably Europe, as they continue to emerge from their own recession.  While certain International – Emerging Markets would seemingly stand to benefit from an improving, developed market global economy, relatively low commodity prices and recent sub-par emerging market equities growth, overall negative sentiment towards Emerging Markets may constrain their growth potential.   Additionally, Emerging Markets with current account deficits in particular will have a tough time as they year unfolds as Fed tapering in the U.S. will have a ripple-through effect on their respective currencies, putting pressure on commodity prices and ultimately hurting certain commodity-based exports. As for International - Developed Markets (Europe specifically), the European Central Bank cut short-term interest rates in November 2013 and we believe that they will continue to keep rates low in an effort to help stimulate growth in the Eurozone. This is reminiscent of the early stages of the U.S.'s own quantitative easing program and therefore we would expect to see an inflow of overall investment to the region.

Should tapering end earlier than expected, the Fed would then be reflecting their renewed confidence in the pace of the U.S. economic recovery. This, in turn, could cause bond prices to go down, with one major and consistent purchaser removed, and interest rates to rise, hurting longer duration fixed income assets and interest rate sensitive investments in general while potentially helping equities, shorter duration corporate and municipal bonds, floating rate notes, cash alternatives and alternative asset classes. Gold, and other precious metals such as Silver, could also be used as a volatility hedge under this scenario, helping it to bounce back from its recent lows.

Given the many moving pieces in the complex, global investment puzzle, investors would be wise, in our view at Hennion & Walsh, to re-visit their asset allocation strategies during the first quarter of 2014 to help ensure that they have the diversification in place to withstand potential periods of heightened volatility as well as the breadth of asset classes and sectors to help deliver risk adjusted growth opportunities in the New Year. 

*The “January barometer” indicator is the hypothesis that stock market performance in January (particularly in the U.S.) predicts its performance for the rest of the year. 

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