Five predictions for financial markets in 2014

By Anatole Kaletsky
January 2, 2014

Happy New Year! For the first time since 2008, we investors, economists and businesspeople say these words without irony. While last year was statistically disappointing, with global growth slowing slightly from 2012 and apparently belying the optimism expressed here last January, the verdict of financial markets and business sentiment has been much more consistent with my predictions. Despite the apparent slowdown, stock markets enjoyed their best performance since the 1990s, long-term interest rates soared and consumer confidence all over the world ended 2013 much higher than it started. This apparent paradox is easily explained: the statistical weakness of 2013 was due entirely to a very weak period last winter, connected with the U.S. presidential election and leadership transition in China. By the second quarter, growth had revived in the U.S. and China and accelerated strongly in Britain and Japan.

That conventional wisdom last January was far too pessimistic about the economic outlook is evidenced by the subsequent behavior of financial markets, where equities outperformed bonds by the biggest annual margin on record. But today almost everyone is optimistic. So what unexpected developments could surprise financial markets and business sentiment in 2014? Below are five personal guesses — some possibly far-fetched and others are seemingly obvious, but none yet fully reflected in market prices:

1. Four is the new two.

I think the U.S. economy will grow by about 4 percent, much faster than the 2.5 to 3 percent predicted by the IMF and mainstream economic forecasts. My reasoning is simple. In the last reported quarter, the U.S. economy was already growing by 4.1 percent and the private sector by 4.9 percent. With U.S. budget battles now over and short-term interest rates firmly anchored at zero, there is no reason to expect a slowdown. If the U.S. accelerates to around 4 percent, so will global growth and 4 percent will replace 2 percent as the growth rate assumed in business and financial planning. Global inflation expectations will also rise to around 3 percent, raising the benchmark for global growth in nominal terms to around 7 percent, very similar to the 10 years before the 2008 financial crisis. In other words, the “new normal” of global stagnation widely predicted after the crisis will turn out to be not very different from the old normal.

2. The big financial trends of 2013 still have a long way to go.

While the gains of over 20 percent in major stock markets may not be repeated this year, equity prices in most of the world should continue rising — and bond prices continue falling. Stock market optimism seems justified for two reasons. Wall Street has now decisively broken a 13-year trading range and past experience, as described in this column last March, strongly suggests that this breakout signals the start of a bull market in global equities that will last for many years. Shifting from history to financial fundamentals, the 6 or 7 percent nominal growth I expect in the global economy should translate into similar growth in corporate revenues and earnings. That would imply similar gains in equity prices, even without any increase in price-earnings multiples or leveraging up of corporate balance sheets through stock buybacks. Given that equity valuations are still only slightly above long-term average levels and that companies are flush with cash, there should be scope for considerably stronger gains in many stock markets.

The biggest problem for stock markets will be higher interest rates, since 10-year yields will rise to at least 3.5 percent as the U.S. economy accelerates. But history shows that stock market prices usually rise alongside rising bond yields during periods of economic recovery, provided short-term rates remain low. And luckily for equity investors, the Federal Reserve will maintain its commitment to zero short-term interest rates however much the economy accelerates, because Fed officials see rapid growth as a natural and welcome development after five years of deep recession.

3. The European crisis will metastasize from economics into politics.

Unfortunately European central bankers have a very different worldview. They see rapid growth as a portent of inflation and will start hinting at tighter money as soon as economic conditions improve. The conflict between strong growth and easy money has already appeared in Britain. It will become a major political problem in 2014, because the improvement in economic activity depends entirely on a property boom that the Bank of England is trying (unsuccessfully) to deflate. As a result, sterling will continue to strengthen, central bank independence will come under pressure and the British economy will become ever more unbalanced, generating the world’s biggest trade deficit relative to GDP. In the euro zone, by contrast, economic conditions will remain feeble at least until the summer, when a shift towards more expansionary monetary and fiscal policies will be triggered by panic in Germany about the big victories for fringe nationalist and neo-fascist parties in May’s European elections. As a result, the euro will weaken and the southern European economies will finally start to recover, but not until the second half of the year.

4. Japan will shoot itself in the foot — again.

Japan is the major economy most likely to disappoint expectations in 2014, making a mockery of the optimism expressed here last year about Abenomics. The consumption tax increase in April will produce a fiscal tightening worth roughly 2 percent of GDP, after allowing for some feeble offsetting measures. As a result, Japan will probably sink back into recession by the second quarter and the stock market will fall sharply, even though the Bank of Japan will try to ramp up its monetary stimulus and the yen will probably weaken even more.

5. Emerging markets will make a comeback — perhaps in unlikely places.

With the U.S. accelerating to 4 percent and China growing steadily in the 7 to 8 percent range, emerging markets will come into their own as investors realize that most of these economies have more to gain from robust economic conditions and stronger commodity prices than they have to lose from slightly higher interest rates. There will, of course, be exceptions. Financial problems may intensify in countries with large trade deficits or political mismanagement, such as Turkey and perhaps Brazil.  On the other hand, two major economies now treated as pariahs could do surprisingly well. In Russia, the recent release of Mikhail Khodorkovsky could signal a newfound respect for private property rights. And a nuclear deal with Iran could bring this potentially dynamic economy back into the civilized world, as well as transforming Middle East geopolitics. But at this point, I am probably getting too optimistic even for a New Year pipe dream.

PHOTO: A reveller (unseen) writes “2014″ with sparklers ahead of New Year’s Eve, in front of the Eiffel Tower in Paris, December 30, 2013.  REUTERS/Benoit Tessie

24 comments

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These ‘analysts’ are so vague and dopey. They are starting to sound like meat-head sports channel analysts.

“We’re gonna see some points put on the board, maybe some ups and downs, given the trends we’ve seen and may or may not continue to see. My prediction is that the team who puts the most points on the board will walk away the winner.”

Posted by AlkalineState | Report as abusive

These really are pretty “safe” forecasts, other than #3 which could go either way.
The US will grow beyond 3% in 2014; all the way to 4% may be a stretch and will depend on steady employment and wage improvements;
The financial markets should continue to improve in 2014 but at a much slower pace than 2013; we won’t (and don’t want to see) see 30% growth in the S&P 500; but 7 – 8% is not beyond reason. Equities are somewhat expensive and corp earnings will have to pick up pace. We will certainly see pullbacks along the way..
I don’t see the Eurozone problems increasing in 2014 and don’t see a much cheaper Euro paving the way for a “PIGS” (except Ireland) rebound – most of south Europe still has significant structural/economic problems (banks, property values, employment, deficits).
Japanese growth will slow with their new taxes but I cannot comprehend them sinking back into recession; slow growth and a market pullback – certainly…
I totally agree that Emerging Markets, after 2 bad years, will snap back – commodities will strengthen due to stronger US and China/Asia growth and this will drive emerging markets. Agree that Brazil is a question mark. I am re-deploying capital to emerging markets now..

Posted by willich6 | Report as abusive

1. Stock market crushes in particular, Nasdaq bubble bursts.
2. The influence of easy money is weakening.
3. Many economic zones are in recession.
4. The housing bubble begins to burst.
5. The difficulties come back to many businesses.
6. Gold crashes.
7. Crude oil crashes.
8. Happy new year.

Posted by gee.la | Report as abusive

Year 2014 has a nick name- the Crash Year.

Posted by gee.la | Report as abusive

1680 is year end S&P.

Posted by gee.la | Report as abusive

I am always the best predictor in this world.

Posted by gee.la | Report as abusive

The bottom of S&P is 1397 or 1389.

Posted by gee.la | Report as abusive

2. The easy money is losing influence from two aspects. The first, the market is losing psychological momentum acquired by the easy money. The second, the easy money is losing the credit for improving economy. It will be seen from the fact that the crash of the speculation brings an apparent damage to the growth. The recovery of economy is caused by the speculation, instead of the intrinsic factors of the economy. So the growth is not as sustainable or stable as it seems. The growth intends to be gone with the speculation.

Posted by gee.la | Report as abusive

The economics needs to be rewritten accordingly. The whole theory of economics is not only wrong but also upside down. The economics encourages the governmental intervention. This ceramic belief and operations cause the Problem. Economic flows should be driven by its own intrinsic force, not by governmental intervention. Governmental intervention only backs the unnecessary speculative force, which weakens the economic intrinsic force and flows.

Posted by gee.la | Report as abusive

Speculation has a character- it stops itself. No speculation is self-sustained . Each is self-damaged. It conflicts itself in such a way that at the beginning act it encourages itself with more easy money coming into, at the ending act, it destroys itself when the credit is gradually being lost. This is not my predication built only on imagination. In short, Fed and other central banks are losing power. This is the natural development for governmental intervention is disturbing the natural and healthy development of economic ecosystem. In the long term, the ecosystem is losing it sustainability and becomes unhealthy. I just simply follow this process.

Posted by gee.la | Report as abusive

Why do we allow these idiots to post their garbage……

Posted by willich6 | Report as abusive

“You know, we have some solid fundamentals to work with on the one hand. Where you do have inefficiencies in the global market, I think you’ll see some of that correct in Q1, but certainly by the 4th Quarter if not earlier. Risks will have to be taken, rewards will be yielded where those risks pay off in their respective sectors and so forth.”

Good times in the world of economic ‘predictions.’ What a douche business.

Posted by AlkalineState | Report as abusive

Let me tell a truth. All GDP data and unemployment rates are falsified. Neither do they have any referential meaning, nor do they tell anything about economy. They are all falsified to make the false theory of economics truthful. This explains that the economics and fundamentals believers are always wrong. Their predications are always wrong, either.

Posted by gee.la | Report as abusive

Why did I predict the GDP in such an accuracy. I didn’t predict the real ‘GDP’ itself, instead, I predicted the politically charged data. Unemployment is in the same pattern. So I predicted them rightly.

Posted by gee.la | Report as abusive

So someone tells you economics is not a science. This ‘economics’ is indeed not a science. It is a superstition and a fraudulent theory.

Posted by gee.la | Report as abusive

Why does it happen so? The most relevant reason is, there is no geniuses in American political system for good decades. So people longing for political power are attracted to such a superstition and they name it the economics. They use it to fill the gap of genius. But still a superstition isn’t a real genius and the real world doesn’t accept it. It is more like communism wasn’t accepted by the real world in the result of disappearance of Soviet Union.

Posted by gee.la | Report as abusive

Actually, I didn’t know I was predicting the politically charged data, I just knew these political figures psychologically so well. As long as you know the people on the subject, you know the subject. If you have no idea about the people, you are always wrong in predictions. So neither is prediction hard, nor is it realizable. Prediction of anything is simply a prediction of the people on the subject. You have to know the people on the subject psychologically. The interest is in this.

Posted by gee.la | Report as abusive

It isn’t a new game. 2,500 years ago, politicians were playing the same game as our politicians are playing. Not only one superstition was invented, but many in layer by layer were invented and they made this political game actually the most complicated- one layer failed, another layer was piled upon the new failure. At last, all these layers of failure had made this game look very stupid.

Posted by gee.la | Report as abusive

All tries at all types of governmental intervention, no matter in what forms or styles, fail, because they all encourage the speculation and discourage the intrinsic self-fulfilling.

Posted by gee.la | Report as abusive

I have bought books by American authors and read articles from US website about new year prediction.

Whats not uncommon is the writers are always optimistic and predict US economy is going to do well. Self assuring and attempt to reinforce to others while displaying how other countries would fail to “catch up” and crumble at their own issues.

But years after years, crisis after another crisis cropped up. Lets be honest and bite the bullet. Every time I see the prediction no. 1 – US economy will remain strong … etc. based on their own simple reasoning. I lose my interest in the book or article.

Guess I am in the wrong site, US edition. ^^

Posted by unknownstranger | Report as abusive

Striking how brain-dead otherwise intelligent people can be one when their thoughts turn to Russia. Russia may very well do better this year – largely due to an upturn in commodity prices, an ever-closer alignment with China, continued if slow reform, and demand growth in her trading partners – but the release of a murderous thug from prison a few months before the end of his sentence will most certainly signify nothing whatsoever.

Posted by EKraus | Report as abusive

Here are my predictions, mainly from a UK perspective. I wonder why you did not comment on currency risks.

http://iforecastuk.wordpress.com/2014/01  /01/predictions-for-2014-and-beyond/

Posted by HumbleThinker | Report as abusive

Wow – if the economic future is so great, then why do we need an extension of the unemployment benefits? According to some “economists”, the economy is on the upswing and that means there should be lots of jobs available, right?

Posted by AZreb | Report as abusive

The fed will start scaling back the bond purchases and the market will decline. It’s not like the stock market means anything to the typical american, other than it is likely to be where they loose their retirement savings. But then, retirement savings should not be in the stock market or mutual funds.

Also, what is the outlook on the oil prices, which are inextricably attached to our economy and is the principle driver of inflation?

Posted by brotherkenny4 | Report as abusive