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Fourth Quarter 2013 Forecast and Opinion

The U.S. economy is growing briskly. Third quarter GDP growth was recently revised upward to a 4.1% annual rate, significantly higher than previously published. Fourth quarter GDP numbers, out in a few weeks, is expected to have been adversely impacted by the Federal government shutdown in October of the Federal government, but there is now clear positive momentum moving into 2014. The official unemployment rate now stands at 6.7%, although this number is distorted by discouraged workers falling out of the measurement after one year of job seeking. Job numbers from ADP, the payroll service company, have demonstrated very healthy signs of improvement. The ADP jobs report measures actual employees being paid by employers in the private sector, and was particularly strong in December, demonstrating broadly based growth in services and manufacturing. Factory orders are improving, new home construction is picking up, and consumer confidence has increased more than forecast, supported by higher employment, higher property prices, higher stock portfolios, and the sentiment that political fiscal gridlock in Washington is less likely to harm the economy. The housing market continues to improve and will be well supported by a backlog of demand; almost one-third of 18-34 year olds in the U.S. are still living with their parents. A continued housing market recovery is “healing” household and banking sector balance sheets.

Surging U.S. energy production and stronger demand for U.S. products has decreased the U.S. trade deficit to a four year low, with California based exporters in particular benefitting the most. The value of petroleum imports, adjusted for inflation, is now at the lowest level since 1996, and should continue to drop significantly in 2014. Meanwhile, gasoline prices are falling, acting as a tailwind for consumers.

Businesses are still behind in their capital investments, and are committing to new plants and equipment. According to the New York based economic research group The Conference Board, real business capital spending growth should improve from 2.5% in 2013 to 4.1% in 2014 and to 4.3% in 2015. This may become a key economic driver this year, as companies replace obsolete and ageing capital stock.

For these reasons, the U.S. economy should continue to improve in 2014. The U.S. stock should continue to rise this year, though at a more moderate pace than in 2013. Large corporations are still flush with cash, and should extend their stock buyback and dividend increase programs. As the Fed winds down its bond buying program, bond yields should continue to climb, causing investors to rotate out of bonds in favor of stocks. While 2013 was marked by an underperformance of blue chip stocks in favor of riskier, economically sensitive stocks,
it is quite possible that 2014 will favor high yielding conservative investments as investors find value in them. Profit margins are still at or near record highs, and the forward P/E ratio of the S&P 500, based on future earnings estimates, is at its long term average level. It is not unreasonable to see further moderate upside to the stock market as long as profit margins remain elevated.

Janet Yellen will take the reins of the Federal Reserve Bank on February 1. Less well known is that as many as six out of 12 Federal Reserve governors and bank presidents will be stepping down this year. These changes represent some uncertainty as to the composition of the incoming members, and whether they are likely to be as favorable to the economic stimulus programs of their predecessors. In December the Fed announced that it would begin trimming its monthly bond purchases from $85 billion to $75 billion, initiating the “tapering” of its stimulus program, which will probably be wound down completely by the end of this year. Until then, there will be continued stimulus to the economy. The Obama administration may nominate Stanley Fischer to become the Vice Chairman of the Fed, which would be welcomed by the market. His success at the International Monetary Fund, the World Bank, and as governor of the Central Bank of Israel makes him eminently suited for the position. Under Yellen and Fischer, it is unlikely that the Fed will begin to raise interest rates until well into 2015.

Democratic Party leaders plan to use the minimum wage debate as a 2014 election strategy on two fronts. The first will be an initiative to raise the Federal minimum wage level by the Obama administration. The second will be to put state minimum wage increase proposals on the ballot in 2014 congressional races. There is widespread public support to raise the minimum wage among both Democratic and Republican voters, and the proposed legislation would increase the Federal minimum hourly wage from $7.25 to $10.10. The strategy hopes to increase voting turnout among Democrat party voters in conservative leaning congressional contests this year. From an economic perspective, this development could result in inflationary pressures since wages contribute to roughly 70% of final product costs.

Developed economies are outperforming emerging markets, but there has been stabilization in the BRIC countries of growth rates. As for the Eurozone, whose unemployment rate remains persistently high at 12.1%, the economy remains fragile, growing only very modestly at less than 1%. European growth is likely to underperform until politicians develop the courage to reform counterproductive labor laws, and implement a full EU-wide fiscal and banking union. Nonetheless, European shares, particularly large cap global companies based in Europe, offer relative value at current levels and are sensitive to any good news.

For the full year 2013, the Dow gained 26%, the S&P 500 increased 29.5%, and the Nasdaq rose 38.2%.

I wish you a happy and healthy New Year, and look forward to working with you in 2014!

Grant Rogers

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