Download Second Half Outlook 2014

the Fed Strategy has been working as the economic
performance for 2014 has been positive.
Investment Commentary
Second Half Outlook 2014
Steady As She Goes
My investment thesis the past eighteen months has
been to expect a slow-growing U.S. economy and
stock market with relatively low inflation and
marginally higher interest rates. I have also
expected the gradual and continual rotation of
investor dollars away from bonds and into stocks.
Interest rates have remained abnormally low due to
the U.S. Federal Reserve’s (The Fed’s) massive bondbuying program, slated for a gradual end later this
year.
For about a year, the (U.S) nation’s central bank has
pumped money into the economy by buying mortgagebacked securities and Treasury bonds. …Fed Chairman
Ben S. Bernanke said the program will probably
continue to shrink in “similar, moderate steps” at
future meetings and end altogether late next year.¹ Washington Post, 12/18/13
The Fed has held to its forecast of a slow taper of
the bond-buying program. This has reassured
investors and the U.S. stock market has traded to
near record highs as measured by the Standard and
Poor’s 500 (S&P 500) Index which closed June 30,
2014 at 1960.23. The markets have traded higher
this year with surprisingly low volatility along the
way, even after a weak first quarter impacted by
severe weather.
Near Term Themes (1-3 years):
The slow ‘taper’ strategy by the Federal Reserve
calls for removal of the stimulus (which is important
to avoid asset price ‘bubbles’) only as the economic
recovery accelerates. The Fed playbook is to avoid
an outcome like that of 1937 (after the Great
Depression) when the premature withdrawal of
stimulus led to another fairly deep recession. So far
After the first quarter’s disastrous -1% GDP showing,
due predominantly to severe weather, we do see signs
of acceleration in key areas. Perhaps the most
important news recently is that, 6 ½ years after the
“Great Recession,” the job market has returned to
pre-recession levels.
For the second quarter…economists are expecting
GDP growth to accelerate to around 4 %... (and be)
broad-based. The Fed’s beige book showed the U.S.
economy is expanding in eleven of its twelve
districts…May automobile sales came in strong,
hitting a nine-year high…and was the highest total
since July 2005, according to Kelley Blue Book. North
American freight shipments also indicate an
accelerating economy…to the highest level since
October 2011. Meanwhile, for the first five months of
2014 shipments were the strongest since the start of
the “Great Recession” according to Cass Information
Systems, a freight specialist.
Sentiment is also too bullish so we would not be
surprised to see a 5%-10% pullback in the next few
months. However, given the excellent momentum and
breadth this market has displayed, we are still looking
for more new highs by year end. We look for the S&P
500 to end the year between 2015-2080.
- Equity Commentary, May 2014 Capstone
Asset Management.
Although near term risks continue to build in
Europe, Russia, and the Middle East, the U.S.
economic recovery continues to advance steadily.
Longer Term Themes (3-5 years): Bubbles?
Favorable themes of energy independence, ecommerce (and ‘the cloud’), modern medical
advancement, and the American manufacturing
renaissance continue to gain traction, providing
sustainable economic growth for the global economy.
The primary risk ‘theme’ for investors remains the
greater likelihood of asset price bubbles due to
outsized government debts from the financial crisis. In
my last commentary I outlined that although the U.S.
has yet to reduce its national debt, its annual deficit
has narrowed significantly the past twelve months and
it remains on track for further contraction. However,
the Eurozone remains behind the curve, and global
debt levels continue to threaten long term asset price
stability.
Bubbling Along
Equity (stock) markets are at risk of becoming
disconnected from earnings growth. Multiple
expansion (investors paying a higher price for the
same level of earnings) drove gains in all major
markets last year with the exception of Japan. This
factor has been behind gains in emerging markets,
the Eurozone and the U.K. this year, even as
earnings shrank in the latter two. Japanese and
U.S. equity returns have been underpinned by
earnings growth, by contrast. Rising earnings may
not translate into positive returns in the short term,
but they are usually rewarded in the long run…In
other words, we do not believe we are in a bubble—
yet. We would get worried if we were to see
leverage rise much further.
- BlackRock Mid-Year Investment
Outlook June 2014.
Thank you again for your patience, confidence, and
trust.
Mark
Mark T. Riefer
President
Conclusion
In light of continued economic growth and
historically low interest rates, I expect U.S.
investors, both individuals and institutions, to
continue selling bonds in favor of stocks. Similar
movements may happen in the European markets,
and this could prove to be a significant story for the
rest of 2014. Although our portfolios reflect broad
representation of market capitalization, we
continue to maintain a slight overweight toward
mid-cap companies. The fixed income/bond portion
of portfolios continues to favor high credit quality
corporate bonds with intermediate maturities.
Given the positive economic fundamentals, we also
continue to utilize higher yielding (lesser quality)
bonds for portions of appropriate accounts.
I had expected more market volatility during the
first half of the year, so I would not be surprised if
market volatility returned during the second half.
As always, I will weigh the merits of possible
investment opportunities in light of market risks at
such time(s).
However, I continue to maintain an overall
constructive view for the investment climate for the
second half of 2014.
¹ ‘Fed to scale back stimulus by $10 billion.’ Ylan Q. Mui,
Washington Post 12-18-13
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