In the world of economics and investments it is always easier to explain what has already happened versus trying to predict the future. Last week I discussed what occurred in 2013, and now I will attempt the more difficult task of trying to make a forecast for 2014.
Looking at the economy, 2014 should be a decent year both nationally and in California. Growth started to improve in the second half of last year, and that trend should continue for the better part of 2014.
Two key areas that propelled growth in 2013 were autos and housing. These areas were decimated in the prior recession, and with considerable pent up demand should continue strong in 2014. Housing prices will likely increase at a slower pace in 2014 due to greater supply and affordability concerns.
Consumer spending should be a positive for the economy this year. The primary determinant of spending is determined by disposable income. Wage gains should be a little better this year, and the unemployment rate should continue to decrease.. Also, 2014 will not have the headwinds of higher taxes, which occurred in 2013.
A positive wealth effect from higher stock market and housing prices will also improve consumer spending. While it is not expected that large numbers of people will take out home equity loans, as occurred in the previous housing boom improved prices do provide an additional confidence boost.
Oil prices have been fairly stable over the past year. That trend should continue, assuming no major disruptions among oil producing countries. In addition, as our oil production expands we have become less dependent upon Middle East oil, which will cushion the impact of any future curtailments in overseas production.
Switching to the investment arena having a very strong year like we had in 2013 causes some people to have completely opposite reactions. One group of people tends to want to sell believing that future gains are limited. The other group wants to buy with an improving market, as their confidence is restored.
There are problems with both approaches. The first approach has some logic, wanting to sell after the market has done well. However, over time markets tend to go up and set record highs. For example in 2012 the stock market was up significantly, so if someone had sold after that year they would have missed all of the gains for 2013.
The other approach buying after the market has had a substantial run tends to do even worse. These are the people who tend to buy near market tops and sell near the bottom. Unfortunately, looking at mutual fund flows we see more people entering the market in 2013 when it is setting record highs, and substantial numbers exiting in 2009, when it was at its bottom.
Looking at the market for 2014 I would characterize it as being fairly valued. Prices relative to earnings are within historical averages, though profit margins are relatively high. This means companies will need revenue growth for profits to grow further.
My outlook for the bond market remains fairly cautious. While 2013 was a poor year for bonds, interest rates will likely continue to move higher in 2014 limiting bond returns. I think having some money in bonds is still appropriate, but keep bond holdings in the short to intermediate category. Having some bond money in a money market account might be advisable, as those funds could be redeployed into bonds later when interest rates rise.
If stock holdings have grown beyond your target range, now would be an appropriate time to reduce your allocation to its normal level. Also, international stocks, notably emerging markets underperformed domestic last year. Adding to emerging markets would be appropriate for those investors with a higher risk tolerance.
On balance most investment professionals are expecting typical eight to 10 percent returns for the market this year. While this might be a reasonable expectation, most years the stock market does a lot better or worse versus its historical averages. Most likely returns will be positive, but nothing like the 30 percent we saw last year.
