Last January, the global economy faced myriad headwinds, choppiness lay ahead, and we expected plenty of volatility. Nevertheless, I said then that risk assets were the best choice for investors. Now, the headwinds of 2013 have largely dissipated, and the outlook is benign for risk assets for the first three to six months of 2014, if not longer.
U.S. equities rose by 10 percent in the final three months of 2013, producing a wealth effect that should pay dividends in 2014. Although the unwinding of inventory that built up in the third quarter is expected to be a drag on fourth quarter economic growth, consensus estimates for fourth quarter GDP growth have risen recently to 2 percent. Improving economic performance should translate into greater confidence, making investors comfortable with more risk, suggesting strong U.S. stock market performance in the coming months.
This cycle is now mature, but expansions do not die of old age. Instead, recessions are generally sparked by an exogenous event or a policy mistake. With little expectation that the Federal Reserve will raise interest rates before 2015, the expansion could continue for several more years. Even when the Fed does eventually hike rates, it typically takes another two years before the economy tips into recession.
The upper limit for 10-year U.S. Treasury yields in the coming months should be around 3.4 percent. With long-term yields rising faster than short-term yields, the yield curve has steepened over the past month and now appears consistent with the better economic momentum we’re seeing in the United States.
The environment for corporate credit feels similar to 2004 – 2005, when interest rates rose modestly, but credit spreads continued to contract, leaving absolute yields relatively flat. If that trend repeats itself this year, then there should be continued opportunities in spread products.
The start of the New Year appears to be a great time for investors, who should take advantage of opportunities presented over the next three to six months.
Reduced Fiscal Drag in Advanced Economies
Major advanced economies (with the notable exception of Japan) should in 2014 have significantly less fiscal policy drag on growth. Leading the way is the United States, where sequester-mandated budget cuts will decrease and the effects of higher payroll taxes should diminish. The euro zone should also benefit as budgetary austerity fades. Britain should also have a slightly smaller fiscal drag. Overall it’s a rosier picture for global growth in 2014, as economies around the world should benefit from faster growth, especially since demand is improving in advanced economies that make up over 40 percent of global GDP.
ESTIMATED FISCAL DRAG ON REAL GDP GROWTH
Source: Haver Analytics, IMF, Guggenheim Investments. Data as of 1/8/2014.
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