The fact is; that global economies are geared towards continual growth, with more ‘up’ years than down, as the world expands in population and technological advances. Answering questions such as why the economy will continue growing, or why the stock market will rise further. But 2014 has been a warning signal, not only for the US, but on a global level, with slowing GDP growth rates, endless stimulation programs from central banks, and rising debt levels.
But the markets keep pushing higher…
And this is Outrageous Predictions – so what can we say?
There have been massive global events ticking away in the background, and yet here we are closing out another strong year for US equities.
For example, we have had to contend with the Eurozone verging on the edge of a triple recession. An escalated war in the Middle-East. A slowing Chinese economy. And the fact that global economic growth has been wound right back to levels not seen since just before the Global Financial Crisis (GFC) of 2008.
At time of writing, the S&P500 index (a key index that represents the broader market performance) had pushed into a new all time high (21st November 2014). Year to date provided a 218 point gain, or 11.8%.
Now, this result meets the 20 year long-term average from 1993 to 2013 of 11.11% annual return of the leading index1.
So making money is all about going with the tide – not fighting it or finding reasons to not believe what is actually happening.
Should the stock market be trading ‘on average’ at a time when global economics are showing weakness?
The World Economic Outlook (WEO) report provided by the International Monetary Fund (IMF) as released in July 2014, stated that the global growth projection for 2014 had been reduced by 0.3% to 3.4%. A subsequent revision in the October update lowered this further to 3.3%.
Economic growth is not measured by a rising stock market.
Key factors such as growth in GDP (Gross Domestic Product – the monetary value of all the finished goods and services produced within a country’s borders in a specific time period), Unemployment, Inflation, Trade Balance, and Debt to GDP (a country’s ability to pay back its debt). Are all important factors.
Growth in an economy means prosperity for its citizens. It means better quality of life, better services, better infrastructure, newer technology and it goes on. And hence, as consumers, we want the stock market to rise on the back of a growing economy.
Amidst the mess, the US is enjoying a perfect storm
Several key elements are in play helping the US which, if they weren’t in play, would mean a more bearish outlook.
The US is now self sufficient in energy and oil and this is massive. This is particularly critical when looking at developments in the Middle East. Prior to self sufficiency, this would be “code red” for the US economy – not any more and with China not yet picking up all the slack, the US is sitting in a very enviable space.
Putting this in a different way, it is now more important for other nations than simply the US, to ensure that the Straits of Hormuz and its precious oil cargo get through without incident.
There are huge shifts in the US and its geopolitical alliances. Imagine the US and Iran teaming up? Well they have, and this reflects a massive shift in the weight and responsibility as being the World’s global policeman.
Similarly, in Europe, take some time and watch the US increase its alliance with Poland – critical to ensuring the previously unthinkable friendship between Germany and Russia (driven by Germany’s need for Russian energy and gas) doesn’t destabilize NATO and its balancing act in the region.
In other words, the US is shifting the game – perhaps in an effort to reduce the vast burden on its shoulders, and economy.
Closer to home
For two decades the offshoring of jobs was a massive theme. Lower wages, leaner and meaner companies with the fat trimmed was also the take away point in the post GFC environment.
However, rising wage costs offshore has put an end to that party. Recently reading an article in the Economist, year on year wage hikes in the order of 20%pa are not uncommon stories.
Add to this the potential for disruption to supply chains (the Japanese Earthquake and Tsunami highlighted this) of requiring components or finished products shipped around the world. Not to mention the costs of having stuff moved around is more expensive now than in the earlier days of offshoring.
Welcome to lower domestic wage costs
Figures through the middle of this year show re-hiring and robustness in the labour market were at pre-GFC levels.
Great for business, great for profitability, great for the stock market – not quite so for the workforce. However, unlike Australia, the US is not a welfare state so any job is a good job.
A great example of lean, mean and working, is the US auto industry. Without the heavy and overblown impact of the Union dictated pay scales, US automakers have effectively been able to halve their hourly rate for workers. Harsh but really the only way the industry could survive in the post GFC world.
So they are local firms but where else has this lower wage environment helped?
Take the BMW plant in Greer, South Carolina. The world’s largest manufacturer of luxury cars opened its facility there, over Mexico for an assortment of reasons – labour costs being one. The company is presently weighing up a second US plant, vs. an alternative in Mexico. Ironic as this may seem, US manufacturing offers high skill and competency levels with low labour costs.
How long can a Central Bank prop up the economy before the Stimulus Bubble bursts?
In November, the People’s Republic of China Bank and the European Central Bank both announced stimulus measures to help boost their economies. The US Federal Reserve has spent the last 6 years pumping hundreds of Billions into the US economy.
So let’s make this simple – cast your mind back to musical chairs – all fun and games until the music stops. The same could be said of the US stock market. It has doubled post GFC and this year is shaping up as another positive one, to add to the tally.
Imagine if you had sat this one out, how far behind would you be?
At some point, the music is going to stop – and when it does, it won’t be fun – hence why every trade should use risk management – always!
In the meantime, bare in mind that investors and markets are inherently positive and optimistic. There is no suggestion that this psychology is likely to change any time soon.
So what does this mean for the stock market?
A definition of a stock market crash is a “sudden and dramatic decline in stock prices across a significant portion of the stock market”.
This will usually be a double digit percentage movement, which will occur over a short period of time. What is a short period of time? This is hard to define, but will usually occur over weeks or months.
Otherwise, the longer the time-frame for the decline, the more the definition becomes a Bear (down trending) market.
Thus far in 2014 (as at 21st November 2014), we have experienced 4 periods where the S&P500 index has declined. These included:
- 113 point decline (6.1%) from 15th Jan ending 5th Feb
- 84 point decline (4.4%) from 4th Apr ending 11th April
- 87 point decline (4.3%) from 24th July ending 7th August
- 202 point decline (9.9%) from 19th September ending 15th October
For a decline to exceed 10% there needs to be cause for concern for investors. At the same time, a 5% market ‘correction’ starts to wave flags in the eyes of investors. Remember, every large stock market decline has been preceded by a minor 5% correction.
So year to date, there has not been anything that would warrant concern from investors, even though the Sept/Oct 9.9% decline was a whisker from technically forming a market crash.
What happened then?
The market very quickly recovered and moved higher, driven again by the psychology of optimism – so don’t fight it!
The chart below shows the US Growth rate at lower levels and slower than the historical norm. However, the performance of the stock market and GDP aren’t joined at the hip – in fact, sometimes they are nothing more than a distant cousin.
What I mean by this is that even in times of declining growth, or even slow growth, we have seen the US market pile on record gains just like the past 5 years, or indeed the post technology crash recovery 13 years ago.
What role will Europe play?
I shouldn’t beat around the bush when it comes to Europe. In 2015, the EU will slip into a recession (another outrageous prediction – two in the one article!), and this will drag both world growth and that of the US. Europe is the fourth largest trading partner for the US and from a trade perspective this will hurt.
However, from a stock market perspective, money flowing out of Europe’s weakness has to go somewhere. Treasuries yield very little and with a flight to quality requirement, there front and center is the US Stock market, primed full of World leading companies that are leaner, meaner and competitive on the World stage.
And investor confidence?
Now of course, confidence is a fragile thing – and it won’t take much for investors to be spooked. Should the S&P500 index hold onto its 11% average for 2014, the probability of producing another average or better than average result next year – well that will depend on a couple of things:
One – what are the investment alternatives – after all money has to go somewhere and secondly, whether the US can stimulate its economy beyond the “bottle feeding” from the Fed.
Lower unemployment, a stronger housing market and a growing wealth effect from a positive stock market will be drivers of this. There are signs that these are all there and in place – the question is how much of that is due to the Fed and how much is organic?
Also, the flip side of the coin is that this generation of Americans, are the first to have a lower quality of life than their predecessors. Not the American dream but very much the reality. Social problems such as Drugs/Crime, illegal immigration and racial tensions are likely to bubble along against this kind of background.
The biggest fight for America – in its history
However, America, when backed into a corner comes out fighting. And this is what needs to happen – not on the battlefield but in the factories, construction sites, manufacturing plants, shopping malls and air-conditioned offices that all drive the World’s largest economy and its stock market.
Tough as this may be, hard work is the new norm for this generation, but at the same time, this could pave the way for a resurgent US economy. It must happen, after all the debt problem of rolling it forward and paying later, at some point will require addressing. However, the “here and now” is that money is being made and quite frankly you need to be in on it to!
Outrageous prediction is that this time next year, if you are not invested in the US equity market, you will regret it – and what’s more you wont get the time or missed opportunity back!!
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Source 1 www.moneychimp.com