The Edmond Sun

January 25, 2014

THE ASTUTE INVESTOR: 2014: Play it again Sam

Nick Massey
Special to The Sun

EDMOND — “Crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought,” said economist Rudi Dornbusch.

Call me old-fashioned but I’m just not buying the “everything is better” story. 2014 will be full of surprises and even more challenging than 2013. This bull market is getting pretty old and nothing goes straight up forever. During the past 110 years, except for the unusual decades of the 1920s and 1990s, a bear market has come along an average of every 4.4 years. The last one began December 2007 — six years ago. You know this thing is headed south at some point. You just don’t know when.

Having said that, it now looks like the next slowdown for the economy and markets likely will take place in late 2014 or 2015. As much as I hate the Fed’s quantitative easing, it has probably bought another positive year for the stock market and risk assets, but at a terrible cost in the future. In many ways, faith in the Federal Reserve today is roughly equivalent to faith in the words “dot com” in 1999. Be careful.

For now, it’s all about earnings. S&P recently posted an update to its 2014 EPS (earnings per share) forecast. The forecast for 2014 as-reported earnings was $106 in late December. Now it’s about $120 — up 13 percent from the previous forecast just a few weeks ago and up 20 percent versus the 2013 estimate of $99.42.

If the forecasters are right, then the P/E (price/earnings) ratio at the end of 2014 will be in the neighborhood of 15, less than the long-term average and down considerably from today. This can only be described as a bullish number.

This type of news normally would point to prosperity across the real economy and call for a celebration — but take heed: Prices do not always reflect reality, and analysts’ expectations consistently tend to overstate actual earnings at tops. They also tend to be too bearish at market bottoms. Basically, analysts tend to forecast for the near future more of what has happened in the recent past. At turning points they really miss the boat.

So what’s in store for the markets and the economy in 2014? Nobody knows for sure, but this is my annual stab at it. While I am quite concerned about the next major market downturn, I don’t think 2014 is it. But if the volatility and uncertainly of 2013 bothered you, 2014 will drive you crazy. Here are my predictions:

• No. 1: I think the market will see a 10 percent correction sometime this year, probably before summer, but recover to finish the year up 8 percent. That would put the Dow around 18,000 and the S&P 500 around 2,000 sometime during the year. Even a correction to 1,700 on the S&P, the current 200-day moving average, would only be an 8 percent correction.

• No. 2: Interest rates on bonds will rise, but not substantially.  That means no bond market crash - yet.  Rates on the 10-year Treasury bond will range between 2.8 and 3.8 percent.

• No. 3: Gold is not dead, but certainly on life support. Gold likely will have a short term rebound to $1,400 before falling to $1,000. Sorry gold bugs.

• No. 4: Barring a big blow-up in the Middle East, oil will trade between $80 and $100 a barrel but will trade more toward $80 for much of the year on slowing global demand, increased supply and easing tensions with Iran. When, not if, the real estate bubble in China bursts, oil could fall even further.

• No. 5: Despite fear of a collapsing U.S. dollar, the dollar actually will rise in value against most other currencies as other countries try to devalue their currencies to make their exports cheaper. This is the 21st century version of trade wars.

• No. 6: U.S. GDP growth is likely to slow in the first quarter as consumer spending slows and the reality of disappointing retails sales hits home. The Federal Reserve and new Fed Chairman Janet Yellen will panic and crank up the printing presses again to slow the current tapering process of reducing bond purchases.

• No. 7: U.S. demographics will continue to be a drag on economic growth and consumer spending as the baby-boomers on average are now past peak spending years and are beginning to spend less, save more and reduce debt. This trend will be in place for at least the next decade.

• No. 8: Forget about employment. The news will always be bad. At this stage of the economic cycle, we should be generating a robust 400,000 jobs a month, not a paltry 200,000. Still, that’s better than 100,000 a month, or none. Yes, we may grind down to 6 percent unemployment, but that will be just because more people gave up looking, not because they got a job. The employment participation rate, the lowest since the ’70s at 62.5 percent, will not change in any significant amount in 2014.

I still think there is a major crash coming, but it is not likely this year. The most likely catalyst for the next crash will be global triggers in major fault-lines like southern Europe and China. China is the next major domino to fall, but trouble in southern Europe and a fall-off in U.S. real estate could add to the problems.

So what should you do with your investments this year? My advice is to tread very carefully and get defensive later in the year if the Dow gets near 18,000. Take advantage of the move up this year and be prepared to protect yourself when the time comes … and I think that is coming sooner rather than later. Thanks for reading.

NICK MASSEY is a financial adviser and President of Householder Group Financial Advisors in Edmond. Massey can be reached at Securities offered through LPL Financial, member FINRA/SIPC.