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The Year Ahead 2014

January 13, 2014
10qk

Gordon Pape

17 followers
By the look of it, 2014 is going to be a mixed bag for investors. On the plus side, the economy will be stronger. On the minus side, investment returns won't be as good as those we enjoyed last year, especially if you had some money in U.S. stocks.

Unless something highly unexpected happens, the U.S. economic recovery will continue to gain momentum. That should translate into lower unemployment and an increase in consumer spending south of the border, while providing a boost for our own economy. The weakened loonie, which last week fell below US$0.92, will benefit Canadian exporters.

You might expect a strengthening economy to provide more impetus to the stock market rally we saw in 2013 but it doesn't work that way. Stock markets are leading indicators. The impressive gains we enjoyed last year, particularly in New York, were partly driven by the assumption that the economy was finally on the mend and that this would result in more robust GDP growth in 2014. The Federal Reserve Board's quantitative easing program, which was pumping US$85 billion a month into the system, also played an important role.

Now the Fed is starting to cut back on its bond buying (to US$75 billion starting this month) and the economy is looking reasonably healthy. Wall Street is going to start paying more attention to stock fundamentals and the numbers are not likely to show the same degree of improvement as they did last year. This will result in a more cautious approach by investors, including some profit taking that will tend to constrain gains in share prices.

Against this backdrop, here is what I expect to happen in 2014.

Modest gains in New York. The major U.S. indexes will have another winning year but the results won't be anywhere near as exciting as those of 2013. Back-to-back years of gains in the 20%+ range are extremely rare. In fact, if it were to happen given the current valuations, it would be very unhealthy and would probably lead to another crash in 2015.

What is far more likely is a year of consolidation, with a fair degree of choppiness. A correction of 10%+ is likely at some stage although the markets will bounce back. The S&P 500 ended 2013 at 1,848.36, which was almost 30% more than its 2012 finish. I expect the index to crack through the 2,000 barrier this year, but not by a lot. Look for a year-end figure of between 1,996 and 2,033, which would mean a gain of 8% to 10%.

Nasdaq was the big dog in New York last year, with the Composite gaining 38% to 4,177. Tech stocks are still popular but some of them have reached price levels that are unrealistic and, I believe, unsustainable. I don't think the Nasdaq Composite will make it to 4,500 this year; instead look for something in the range of 4,428 to 4,470.

I don't put as much credence in the Dow Jones Industrial Average as many people do because it is so narrow (only 30 mega-cap stocks). It didn't do as well as either the S&P 500 or Nasdaq last year but because of its large-cap nature it might outperform both in 2014 due to the more cautious approach I expect to see from investors. It ended 2013 at 16,577; I'm looking for between 18,100 and 18,235 by the time this year is over.

A surprise from the TSX. For a while, it looked like 2013 would be a dreadful year for the TSX. As it turned out, a last-minute rally pushed the S&P/TSX Composite to an acceptable gain of 9.6% to finish at 13,622.

Most analyses I've seen are pessimistic about the outlook for the TSX this year, mainly due to continued softness in commodity prices. I think we may get a pleasant surprise here. The resource sector was a disaster zone in 2013, led down by the gold miners. It's hard to imagine a repeat of those dismal numbers. The collapse of BlackBerry's share price was another blow. In fact, it's a wonder the Composite did so well, contending as it did with those drags.

This year I think we'll see a better performance from the mining sector, if only because it can't get much worse. Financials won't do as well (they were up 22% last year) but we should see an advance in the 10% range in that sector thanks to dividend increases. Watch for Industrials to be a pleasant surprise, buoyed by better export sales due to a weaker loonie. The sector gained almost 35% last year, albeit from a low base. We may not do as well this year but I expect an advance of at least 15% to 20%.

Interest-sensitive sectors such as utilities and REITs will continue to be weak if there is continued upward pressure on interest rates so you may wish to underweight exposure here.

Overall, and I'm going out on a limb, I can see the TSX moving through 15,000 this year with a gain in the 11% to 12% range. For the first time in several years, there is a chance it could beat the S&P 500.

Global markets to be mixed. Many investors were surprised at how well global markets performed in 2013, with the MSCI EAFE Index, which reflects developed markets, adding 23.8%. I can't see a repeat of that in 2014, or anything even close. Japan's results were out of sight, with the Nikkei gaining more than 50%. Europe's key markets also posted big gains - too big in relation to the continent's economic recovery. I can't see the EAFE Index adding more than 10% this year, and frankly I'll be surprised if it manages that.

Conversely, we should see a better performance from the emerging markets. The MSCI Emerging Markets Index lost 2.6% in 2013 and has a losing record over the past three years. The improvement in the global economy, led by the resurgence in the U.S., should improve the fortunes of these countries. China is the largest geographic component of this index and we should see better results from there in 2014 (Shanghai was down 6.7% last year while Hong Kong gained only 2.6%). This is my dark horse pick for the coming year, but it's strictly for more aggressive investors. If all the pieces fall into place, we could see a rise of 10% to 15% in the MSCI Emerging Markets Index.

One way to play this is by buying units of the iShares MSCI Emerging Markets Index Fund (TSX: XEM) which was originally recommended by contributing editor Gavin Graham. It was up only 2.3% last year but I expect better results in 2014. The units closed on Friday at $24.75.

Frontier markets may also do well in 2014, for many of the same reasons. The iShares MSCI Frontier100 ETF (NYSE: FM) was up 25.6% last year.

Bonds will struggle. Rising interest rates are toxic to bond prices, as we saw last year. The bond bull market came to a sudden end with the DEX Universe Bond Index actually losing ground in 2013, something that rarely happens. Expect more of the same this year, although the impact may not be as dramatic. With inflation still very low, neither the Bank of Canada nor the Federal Reserve Board is expected to raise their key lending rates. In fact, there is even some speculation that the BoC might lower its target rate if the economy lags.

The net result, I believe, will be a small gain for the bond indexes this year, with the DEX Universe Index gaining 1% to 2%. The best choice for conservative fixed-income investors will continue to be short-term bond funds while more aggressive investors may want to put some money into high-yield bond funds. If you believe the loonie will continue to sink against the greenback, Maple Bonds, which are denominated in U.S. dollars, are worth considering. The iShares DEX Short Term Corporate Universe + Maple Bond Index Fund (TSX: XSH) isn't a pure play on Maple Bonds but it offers some exposure.

GICs rates stay low. I don't expect any great leap forward in GIC returns this year. Financial institutions are in no hurry to raise their payouts, even though mortgage rates have moved higher. Very conservative investors are going to have to continue to live with low returns. Last year I set a target of 2.5% on five-year GICs from the major banks. We didn't make it. This year we should get there, but not much higher.

Gold stays in the doldrums. With inflation low, QE tapering off, and no international crises on the horizon, there is nothing to fuel a major rally in gold, despite the recent upward move. There's always the potential for surprise, of course but unless something unusual happens bullion will have a hard time staying above US$1,200. In that scenario the gold miners will be stuck in neutral. I don't expect to see the huge losses in that sector that we experienced in 2013 (-48.4%) but neither are we likely to have big gains.

The loonie will rally. Our dollar has fallen very far, very fast. It lost 7% of its value against the U.S. dollar last year and the downward spiral continues. Some economists are now predicting it will drop below US$0.90. That may happen in the short term but I doubt it will be sustained. I expect the loonie will rally after mid-year as the economy gains strength and end 2014 somewhere in the range of US$0.94 to US$0.96.

To sum up, here are the main points to keep in mind for the coming year.

1. Growth stocks offer the best potential in 2014, assuming the economic recovery gains momentum

2. U.S. markets will continue to advance but at a slower pace.

3. The TSX may top last year's result by a small margin.

4. Overseas, emerging markets are poised to rally and may outperform the developed EAFE markets.

5. Fixed-income securities will continue to be weak but we could see modest gains.

6. GIC rates will remain low.

7. Gold will stagnate.

8. The loonie will rally from its current slump.

A year from now, we'll see how this all plays out.

About the author:

Gordon Pape
GuruFocus - Stock Picks and Market Insight of Gurus

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