By Calamos Investments – Entering 2014, we expect a good year for global equity and convertible markets overall. The major global economies look positioned to show faster growth, although this positive global synchronization is occurring at varying rates and supported by diverging policies. Historically, the conditions we see today have benefited equities and convertibles, especially cyclical growth opportunities. More importantly, we are encouraged by the emergence of more fundamentally driven markets across asset classes and believe that our active approach is well suited to this environment.
The S&P 500 Index rang out 2013 with a total return of 32%, its strongest year since 1997 (Figure 1). The Nasdaq Index soared even higher to a 40% gain for 2013, on the back of an increased appetite for risk assets, including smaller cap and technology names. Developed markets outside the U.S. also advanced briskly, supported by improved conditions in the euro zone and brightening sentiment on Japan.
In terms of market performance, the emerging markets (EMs) did not enjoy similarly good fortunes, as market participants struggled with the potential deleterious impact of a U.S. taper on countries with weaker currencies and deficits; these anxieties were exacerbated by concerns of slowing growth. Talk of a potential credit bubble and slowing growth in China was a focal point of investor apprehension.
As is often the case, good news for U.S. stocks was bad news for much of the bond market, and the 10-year Treasury sank 8% for the year. Gold declined nearly 30% as inflation remained contained and equities extended their rally.
For the year, consumer discretionary led, as companies continued to reap the benefits of the wealth effect provided by rising equity markets and recovering home prices. Health care and financials rounded out the top performing sectors.
For the quarter, cyclical growth sectors performed best, led by industrials and technology. Utilities and telecom posted the most muted gains for the quarter and the year, as investors turned away from more defensive names.
While improved global economic growth in 2013 was led by the U.S., we are starting to see positive global synchronization among major economies. Europe is coming out of its recession, and Abenomics has promoted economic growth in Japan. China’s growth has decelerated, but it is delivering solid growth nonetheless, as are a number of lesser-discussed EMs.
In the wake of the 2008 financial crisis and euro zone turmoil, accommodative policy was good for the global economy. Recovery efforts didn’t take firm hold until the U.S., the European Central Bank (ECB) and China aligned in an accommodative direction. Now, with the worst in the rear-view mirror, countries are following different routes to move forward as they address local issues.
The U.S. is tapering; elsewhere in the developed markets, monetary policy remains highly accommodative and fiscal policy has become more stimulative. The ECB has indicated its willingness to inject more money into the euro zone, and Japan looks set to continue with its unprecedented stimulus measures. China and other emerging markets will likely be in varying levels of tightening as they work to avoid credit bubbles while keeping inflation in check. All in, we expect global growth slightly above 3.0% (Figure 3), with the U.S. and China making strong contributions. As the two largest economies in the world, their economic growth can offset the more modest expansion that we may see in the euro zone and in some EMs.
United States. The U.S. economy looks to be in a “nottoo- hot, not-too-cold” period, supported by improving GDP growth and low inflation, upbeat consumers, good corporate balance sheets, strength in manufacturing and an improving trade balance. We expect U.S. GDP growth of 2.5 to 3.0% in 2014, with inflation holding at less than 2%. Against this backdrop, we anticipate that the Fed will withdraw QE stimulus by the end of 2014, while continuing accommodative policy through 2015.
Supported by a wealth effect of rising equity markets and home values(Figure 4), the U.S. consumer is feeling better and spending more, including on autos and other discretionary items (Figure 5). Net worth is higher than it was before the financial crisis, and the deleveraging cycle may have well have bottomed out (Figure 6). This willingness to spend and potentially take on debt should sustain economic growth over the long term.
The U.S. Labor Department’s report that only 74,000 jobs were added in December fell far short of economists’ expectations(Figure 7), but we expect the number to be revised upward next month. The calendar was compressed with Thanksgiving coming late; the weather was bad; and if one considers November data (revised up to 241,000 jobs) along with December’s data, the average monthly job growth has been respectable at about 160,000. The December numbers are also inconsistent with the other stronger economic data we’ve seen over the past few weeks, including new unemployment claims and ADP’s private sector job growth report.
Businesses are also doing well. Capital spending has begun its long-anticipated recovery, with total expenditures at record highs. Corporate cash growth and high cash balances suggest that this recovery can be sustained over an extended period. Operating earnings of S&P 500 companies continue to rise. Small businesses are adding jobs and benefiting from increased access to credit. As earnings season starts again, we believe most sectors are likely to do better versus reduced expectations. Retail and restaurants may be an exception; like the employment numbers, these sectors were similarly affected by the compressed calendar and weather.
What could derail this recovery? We believe the most significant threat to U.S. economic growth is inflation, which would cause long-term rates to spike. At this point, we believe the threat of this is low. Wage inflation is not a problem, as unemployment is still relatively high. At 1.5%, core inflation is well contained today and looks to be so for the foreseeable future, while the velocity of money, a primary driver of asset inflation, remains subdued ( Figure 8 and Figure 9).
We also view government policy as a potential impediment to a more robust recovery. We’d like to see more favorable fiscal policy for business, which in turn could stimulate job growth and GDP growth. It’s our hope that Congress will focus on this in 2014.
Euro zone. We believe GDP growth is likely to turn positive in 2014, led by stronger growth in Germany and more stimulative fiscal policy. Stronger U.S. growth should also benefit the region by creating demand for European exports. While we expect regional expansion, the growth will be uneven by country. Germany has continued along the recovery trajectory. Spain, Ireland and Greece have gone through painful austerity programs and appear headed to brighter prospects.
Countries that have not undertaken reform may remain or become potential problems. In France, manufacturing has fallen significantly, public debt has soared to more than 90% of GDP, and President Hollande’s aggressive tax agenda has discouraged private enterprise and investment. Due to its size, even a relatively small stumble from France could cause a large impact.
More broadly, structural issues across the euro zone continue to create considerable headwinds to more robust growth: money growth is slow, bank loans have declined, and unemployment remains at more than 10% for the region, with youth unemployment even higher at 23% (Figure 10).
So, while the Fed is ready to start weaning its patient from its meds, the European Central Bank likely has more to administer. While the exact prescriptions are to be determined, the ECB has alluded to providing liquidity exclusively to banks that commit to extending those funds to businesses. In this case, attaching conditions to banks’ ability to access additional capital would be a positive because we believe stimulating business is the long-term route to economic growth.
Japan. Markets have loudly cheered Abenomics, with the MSCI Japan Index (local) rising 55%. With the printing presses working overtime, Japan has doubled its money supply, and the yen is down 20% since the outset of Abenomics. Economic growth was strong during the first half of the year, but slowed more recently (Figure 11). The trade balance remains problematic, hindered by tepid exports. Ebbing domestic consumer demand provides further cause for concern.
In our view, the Japanese equity market may have gotten ahead of itself in 2013, especially as the sustainability of the recovery is contingent on meaningful structural reform. Persistent overcapacity issues and stagnant wage growth create significant hurdles to more sustainable economic growth. We expect consumers to pull spending forward before the introduction of the value-added tax this spring; this could lead to a near-term boost to economic growth, but it’s too soon to gauge the longer-term impact of the tax.
Emerging Markets. While we expect broad global economic synchronization overall, the expansion will be uneven. Most broadly, the secular growth trend of the emerging market middle class consumer remains intact. On a country level, we are seeing encouraging reforms in China, Mexico, the Philippines, and South Korea— reforms that have the potential to improve longer-term economic growth prospects, including stimulating foreign direct investment.
In regard to China, we are not anticipating either a hard landing nor a significant acceleration of growth. Rather, we believe the economy will slow to a still-healthy 6% range for the medium term. We are prepared for bumps along the way, as the influence of state-owned enterprises (SOEs) decreases and the role of private enterprises expands.
In Mexico, President Nieto’s “Pact for Mexico” has unified opposition parties to implement structural reforms. In the Philippines, economic prospects have been bolstered by President Aquino’s government’s successful strides against corruption, helping to level the playing field and encourage foreign investment and private enterprise. Moreover, since Typhoon Haiyan, the Philippine government has also shown greater momentum in moving forward public-private partnerships to build infrastructure and promote private enterprise. (For more on Mexico and the Philippines, read blog posts by Co-Portfolio Manager Nick Niziolek, CFA, at www.calamos.com/viewpoints.)
However, the upcoming taper in the U.S. and the aggressive monetary accommodation in Japan give many emerging markets less room to navigate as they attempt to forestall inflation without curtailing economic growth. Saddled with a fiscal deficit and a current account deficit (“twin deficits”), Brazil is in a difficult spot as it seeks to combat slowing growth and high inflation, a challenge made more difficult given our expectation of softer commodity demand and rising real interest rates in that country. For many similar reasons, we’re cautious on India’s growth prospects, as the government struggles with economic deceleration, rising inflation, a twin deficit, the shadow of a potential ratings downgrade of its debt, as well as a fractious political environment.
Moreover, India and Brazil are two of the five major EM twin-deficit economies with national elections scheduled in 2014; the group is rounded out by Indonesia, South Africa and Turkey. The outcomes will likely lead to structural changes, but whether positive or negative remains to be seen. We should be prepared for more volatility along the way.
For more info visit www.Calamos.com
Past performance is no guarantee of future results. Source: Robert Shiller, National Bureau of Economic Research, Federal Reserve Board, Standard and Poor’s, Corporate Reports, Empirical Research Partners Analysis. 1Capitalization-weighted data.
Source for forward P/E and nominal GDP estimates: Empirical Research Partners.
The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Information contained herein is for informational purposes only and should not be considered investment advice.
Opinions, estimates, forecasts, and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. We believe the information provided here is reliable. The views and strategies described may not be suitable for all investors. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations.
The S&P 500 Index is generally considered representative of the U.S. stock market. Unmanaged index returns assume reinvestment of any and all distributions and do not reflect fees, expenses or sales charges. Investors cannot invest directly in an index. Price/earnings represents market value divided by expected earnings.