The bull market that began in March 2009 has survived steep unemployment…slow US economic growth…a series of fiscal cliffs…a European debt crisis…Middle East upheaval…and a slowdown in China's economic growth.
But can the stock market continue to thrive into a sixth year and rise in 2014?
Can it overcome an expected rise in interest rates and the continued political warring in Washington, DC?
Top economist and regular Bottom Line/Personal contributor Allen Sinai says "yes." He predicts that stocks, which have returned more than 180% since the market bottomed in 2009, will rise another 13% to 15% in 2014.
Here's why Sinai is confident despite the formidable challenges ahead—and what it means for your investments…
The same conditions that propelled the stock market upward since 2009 remain largely in place. The economy is growing at a slow pace with very little inflation. Household wealth is increasing. Consumers are better off. Companies have learned how to be profitable even in a slow-growing economy, and their balance sheets show record amounts of cash.
But the optimism is tempered by the endless political dysfunction emanating from Washington. Throughout 2013, Congress created a drag on economic growth and raised anxiety among businesses and consumers with its draconian budget cuts known as sequestration and the recent government shutdown. That shutdown and the threat that the US would default on its bills likely shaved up to one-quarter percentage point off economic growth for the second half of 2013, which I think will cause the year to end with an anemic annual gain in US gross domestic product (GDP) of just 1.8%.
There's more political brinkmanship ahead in 2014. By January 15, Congress needs a deal to continue funding the government and avoid another shutdown.
A few weeks later, on February 7, it needs to again extend the nation's borrowing authority. Congress also has been trying to tweak the sequestration formula before billions of dollars in additional heavy-handed budget cuts take effect.
A deadlock over these issues could harm the economy, hurt corporate profits and drive up long-term interest rates. But despite all the manic maneuvering, I don't expect another government shutdown, because members of Congress face midterm elections in 2014 and don't want to further anger voters.
The one positive note for investors in all this chaos is that the disruption to the economy has influenced the Federal Reserve to keep its massive economic stimulus program intact. It has continued to pump $85 billion a month into the economy through purchases of Treasury and mortgage-backed securities, and that has kept interest rates down and stock prices up.
Everyone has been speculating about when the Fed might begin to slow down, or "taper," its monthly purchases. Given recent conditions, I expect a slow phaseout of the stimulus program to begin by next spring. Much of the stock market's performance and volatility in the second half of next year could depend on the exact timing and magnitude of the phaseout.
The underlying fundamentals of the economy and strength of corporate earnings will continue to hold up. I do not expect the Fed to raise short-term interest rates at all in 2014—such a move would jam a wrench into the equity bull market.
Those rates have been at a historic low between 0% and 0.25% since December 2008 and likely won't rise until early-to-mid 2015. The Fed has said that it does not plan to take such action until the unemployment rate drops below 6.5% and/or the inflation rate rises to 2.5% or higher.
Here's what to expect for 2014…
The interest rate on 30-year fixed-rate mortgages likely will hit 4.8% by the end of 2014, compared with 4.16% in early November 2013. Despite that, home prices should advance by nearly 10% in 2014 as banks relax lending standards, inventory levels remain low relative to what we have seen in the past and buyers take advantage of rates that still are historically very low. However, price appreciation will be distributed quite unevenly across the country, with certain areas, such as Arizona and California, much stronger than others.
Stocks should do well next year, driven by better corporate earnings, which I expect to rise by 8% to 10%. But even if stocks emerge unscathed by the actions in Washington, DC, they are unlikely to repeat the robust gains of 2012 and 2013, simply because valuations are higher. The S&P 500 is reasonably priced now but no longer cheap, with its component companies trading at an average of 18 times earnings for the past 12 months. That's higher than the historical average of 16.
The Standard & Poor's 500 stock index should continue to hit all-time highs, advancing about 13% to 15% for 2014 and approaching 2,000 by year-end. The Dow Jones Industrial Average will have a similar percentage gain—to near 18,000.
Best areas of the stock market now…
The bond market, including corporate and government bonds, will have another disappointing year in terms of total return. Expect low single-digit returns at best as investors continue to find the stock market a more attractive place to put money. The steadily improving economy will help push up long-term interest rates, and the 10-year US Treasury yield—recently 2.7%—should be in the range of 3.25% to 3.5% by year-end. However, if Congress fails to extend the debt ceiling, the US will see its credit rating lowered and spooked investors could push Treasury yields up and the prices of most bonds down. Therefore, if you do hold bonds, it is more vital than ever to protect yourself from losses by keeping their maturities at short-to-intermediate term lengths.
Source: Allen Sinai, PhD, president and chief global economist of Decision Economics, Inc., a global economics and financial markets advisory firm based in New York City. Over several decades, he has advised policy makers in Washington, DC, Japan and elsewhere, including Republican and Democratic presidential administrations. DecisionEconomicsInc.com