2013 4th Quarter Economic Update and Quantitative Easing

Happy New Year…and may it be a prosperous one! This is a time for celebration, new beginnings and resolutions but also a reflection on the year that has passed. As 2013 drew to a close, the United States found itself slowly recovering from a financial crisis in an environment rife with political discontent. The S&P 500 posted its largest annual jump in 16 years, closing the year up 29.6%. Home prices also rebounded and combined with the rise in stock prices, helped to repair consumer balance sheets. The unemployment rate remains stubbornly high, although it is slowly dropping. Investors continued to find little reason to own gold, opting for higher yielding, riskier assets. Government bonds were shown no love in 2013 and the bond market in general became a cause for concern as the long standing bull market in bonds finally winded down. Finally, the much maligned European economies, in general, returned to growth, albeit slow and weak. Concerns over the Eurozone’s debt crisis faded, largely due to improved responses from the European Central Bank.

The world’s largest economies have been dominated by the massive expansionary monetary policies of their central banks in an effort to curb long-term interest rates. There may be negative side effects from these actions in years to come. The generation of asset bubbles immediately comes to mind. So does a worsening of inequality. Asset prices have increased faster than income. The top 10% of households account for 50% of taxable income but 75% of total wealth. The current monetary policies designed to prevent inflation may actually foster inflation in years to come. Lastly, there has been an avoidance of governmental fiscal reform, which is rather unfortunate but I am hopeful that this will change in the future as governments finally realize that we cannot “grow” ourselves out of the financial trouble that we are in.

Quantitative easing should end in 2014 in the United States as the government phases out the bond buying program, which should lead to higher government bond yields. The focus would then shift to a rise in US interest rates and increased volatility across all asset classes. This may lead to a continuing flow of money into equities. Although the timing of the first Fed funds hike is not certain, most economists predict it will not be until mid-2015 since our economy remains too weak to withstand it. We are still not seeing the job creation that the United States needs to employ new entrants into the workforce and also alleviate some of the unemployment that resulted from the economic recession.

Valuations in the equity market seem fair right now but bull markets don’t usually stop at fair market value. If optimistic analysts are correct and 2014 is a year of equity bulls and bond bears, it will represent the sixth year of the US equity bull market, which began in March 2009 at the end of the Great Recession. I think it is prudent for expectations to be tempered for 2014 though. The economy has improved and the tapering has finally begun but this will not necessarily translate into much higher market returns.

I find myself asking what will shape the global economic and investment environment in 2014. Inflation and interest rates are low in most of the world. Companies are sitting on cash and there is plenty of pent-up consumer demand. However, the world’s economies are having difficulty accelerating after the 2009 downturn. China, the number two world economy, which has decelerating growth, is a variable due to its governmental policies. The European Union will continue to be a trouble spot as economically strong Germany contends with economically troubled Southern Europe. However, I think two of the most important uncertainties are the Fed and Congress. Global businesses are hopeful that the US government can reach deals with minimal dysfunction, which would be a refreshing change from 2013. They are also hopeful that the new Fed chairman, Janet Yellen, can taper as well as Ben Bernanke spent. Businesses despise uncertainty and the greatest threats to US growth in 2014 are internal and much depends on the success of the Fed and Congress.

Please find enclosed your 4th Quarterly Portfolio Report for 2013.  If you have any questions or concerns, please call me at 518-328-8104 or email me at olivia@mussettwealth.com.

Warm regards,

Olivia A. Mussett, CFP®