This time last year we were bullish about equities and positive on the slow but steady strengthening of the economy. The market did not disappoint. The economy was almost heroic, you might say, with its performance enduring government sequestrations and higher taxes almost a 2% drag on GDP but comporting with our expectations of 2 – 2.5% growth. 2013 is ending with GDP and the markets coming fairly close to what we thought they’d achieve. Now the year is almost out, so let’s take stock of 2013 but look ahead to 2014.
Markets still a bit wobbly
Against a backdrop of “taper hangover” at the prospect of the government winding down its bond-buying stimulus, new home sales, new home prices, and retail sales are all looking a little bit wobbly. This may have something to do with the cost of capital for private borrowing increasing across the board with the yield curve rising a 100 plus basis points after Treasuries sold off in the summer. So if you’re taking out a new mortgage, you have to think a little bit longer about whether to buy a house whose price is up fairly substantially from two years ago.
That sort of thing will generally put a little bit of hesitancy into markets.
Good news as bad news to some
Ironically, the market seems to treat good news as bad news, especially as it relates to the taper talk, as there is upward pressure on Treasuries and a lot of volatility keeping the market on tender hooks.
However, car sales are strong. Employment and wage growth looks to be improving. State and local governments are actually now in a hiring phase (Detroit and Puerto Rico aside). And we feel pretty confident that we’ll get back to higher housing numbers in 2014.
Companies and Congress getting in the spirit
We believe corporate capital expenditure will continue to accelerate through 2014 as companies feel better about the
underlying economic environment. Perhaps they will find out that Obamacare may even serve as a boon for them. For the first time in a long time we’re seeing health care inflation flattening out so that as consumers actually become true consumers of health care, they may well force a bending of the cost curve in the health care industry.
The political backdrop in Congress appears to be moving to some type of budget consensus that would avoid another shutdown. Once we get through this transition period and into some more confirming economic data, I think the equity markets will lose some of their wobbliness.
Investment opportunities in 2014
Looking ahead, we expect the upward pressure on Treasury yields to continue, but not like we experienced in the summertime selloff. That event weeded out a lot of investors who had become too sanguine about low rates forever. As a result, that trade is not so one-sided anymore. We think the 10-year Treasury’s yield will probably get to 3.25% – 3.50% next year – meaning another 40, 50-70 ba-sis points of widening ahead of us in 2014. That action will clearly not be favorable for high quality fixed income.
High yield and has some room to continue to tighten and provide a positive return relative to Treasuries and mortgages and investment grade, in our view. We think bank loans will continue to be a reasonable asset class and outperform next year. We will probably continue to mine opportunities in the long-end of the credit curve and the investment grade world where we foresee significant sell offs in some of these bonds. We are concerned about the impact that a further selloff in Treasuries could have on emerging markets, so we will continue to be very selective there.
We think 2013 was a pretty good year both economically and if you were in risk assets. As we look to 2014, it’s hard to see that story being derailed. Best wishes to all.