Stock market corrections tend to be triggered by widespread fears of an imminent recession. It’s hard to see a significant correction ahead if the big worry is that better-than-expected economic indicators might cause the FOMC to taper QE by $10 billion to $15 billion per month. Just because there are too many bulls and the Fed will continue tapering doesn’t mean that stocks can’t make new highs. Personally, I’m rooting for a refreshing pause, but it’s not up to me. Global growth should accelerate in 2014, mainly driven by reduced austerity in advanced economies. Expect decent growth in the US as the housing and labor market recoveries gain pace, while the Eurozone returns to its first year of growth since 2011.
There are very few positive political developments in emerging markets (EM) at the moment. Just in the past month we have seen the parliament in Thailand dissolved, massive protests in Ukraine, police force strikes in Argentina, and even highly unusual rioting in Singapore. We may see further political risk rotation from developed markets to EM in 2014. The “Fragile Five” EMs – South Africa, India, Indonesia, Brazil, and Turkey – have high inflation, large current account deficits, challenging capital flow prospects, weak currencies and weak growth. In addition, all the Fragile Five have elections in 2014, and each one could be a political landmine. Economic growth has produced a large, politically active and relatively frustrated middle class. In the context of subdued global growth, this middle class is beginning to realize that the last decade of high EM growth has brought little improvement in their actual quality of life and little in the way of pro-market structural reforms. Expect EMs to remain vulnerable to rising global interest rates, lower commodity prices, and political instability.
Watch out for unrest in the EM. Over the past several years, much analysis has focused on the supposed coming social unrest in Europe and the U.S [remember Occupy Wall Street]. However, these forecasts ignored the facts that developed economies – particularly European ones – have relatively low income inequality, high levels of household wealth, broad safety nets, do not suffer from persistent inflation, and enjoy a much higher quality of governance when compared with most EM economies. Even Europe’s Mediterranean countries, the most politically strained of the developed market economies, have much higher levels of governance quality than most EM economies. Thus, the first half of 2014 is likely to see a continuation of 2013’s capital outflows from EMs and inflows into developed market equities.
Emerging markets have become victims of their own success. Other than Mexico, which is plowing ahead with very controversial and politically sensitive reforms, the rest of the EM economies are not making headway in terms of structural reform. Many emerging markets, largely the deficit EMs, are battling uncomfortably high inflation even as growth continues to moderate well below trend. The pain is likely to get worse with downside risks to domestic demand and overall growth before any competitiveness gains kick in.
Expect 2014 to start choppy after the run up in stocks and US interest rates in 2013. None-the-less, US growth is set to pick up speed on the back of a lesser fiscal squeeze and private sector strength. The economy has been cleansed of the excesses of the past and has regained its global cost competitiveness. Overall, strong housing and wealth effects, cap-ex, energy output, and world trade, combined with a highly competitive dollar, could raise growth above 3% during 2014.
Michael Ashley Schulman, CFA
Hollencrest Capital Management