We started the year with a special report anticipating how 2014 will be for the world economy and financial markets. The Federal Reserve surprised everyone when it decided to cut its bond-buying program. The market expected the event to occur much later.
The figure of the cut was not as pronounced, just a total of $10,000 million. This figure compared to the huge amount figure for buying bonds is a fraction. This seems to be a market test and then go forward with a more pronounced cut. The reaction to this cut was optimism, major indexes rose more than 1% that day. The market interpret that the economy was strong enough to start reducing stimuli.
Another good news was that unemployment also fell more than expected, a 7% and GDP growth rose to 4.2%. This could be a sign that the Fed will start to decrease bond purchases in a meaningful way. While the outlook is optimistic, we know that any surprise of the Fed could cause the market to correct sharply.
Everything depends on the evolution of economic data, as the new chairman of the Fed, Janet Yellen said on several occasions that she will continue with the policies of Bernanke. On the other hand, the revenue growth is more due to the cost cutting measures of large companies. So this year the numbers could surprise the market. After strong gains at the start of a recovery, it is absolutely normal that profits stabilize for a while until it begins a second stage of recovery.
The year 2014 could be the beginning of the second stage. As consumers and businesses increase demand for goods and services, sales eventually becomes a more important factor in earnings. Are we witnessing the launch of a new economic cycle? It seems that the same cycle that began in 2009 is closing, an extremely volatile cycle indeed.
If GDP growth and earnings increase its growth rate in 2014, with this should raise stock prices so we can expect a positive good year.
A market too optimistic?
Positive economic news coming out in the media, and recent data on projected GDP growth, income growth, housing and unemployment, do investors expect a year of economic bonanza. This makes us think about the market and its behavior. Could this start a stage of euphoria in the stock market? If this happens in the market means that prices will rise beyond what is suggested by their actual values. This situation could generate a dangerous financial bubble.
At the moment there is no bubble scenario in action, but as we know, the media play an important role. When the headlines begin to be extremely bullish better be careful and know when to quit. Valuations should be realistic and stay for economic recovery. We should note that there is a lot of cash out of the market at this time, trillions of fact. Bear markets usually occur when there is not much money without investing.
Problems that could affect the economy in 2014
It is time to assess the risks of the new year. There are several major conflicts that could hit, and that could impact the market for some time. This year we could feel the effect of the problems in South Africa. Its currency is in deep decline, there is a growing budget and trade deficits and slowing growth. To this is added the political crisis and the government's disapproval.
It is very possible that the rating agencies debase the South African debt causing foreign money to escape. This could be extended to other emerging markets. Europe is not without its problems, has barely made it out of the recession. This recovery was led by Germany and the UK, which have had significant economic growth.
The real problem in Europe is political as we saw during all 2013. Now many hostile parties to the EU itself can gain control in the Parliaments. These political parties with an ideology contrary to the European Union could take over and cause problems to the stability of that area.
What can we expect from the market in 2014?
Every year brings surprises that could cause volatility in the market temporarily. Some things are unpredictable, but even with the problems that might arise, there are strong reasons for optimism in 2014. Growth should pick up, which in turn should help increase profit margins and minimize unemployment. There is too much tailwind for 2014 not to be a good year for the economy and the financial markets, including Forex.
There will likely be surprises along the way. We could see that the correction that never came in 2013, but the U.S. economy appears strong enough to handle some contrary events. With these findings we said goodbye until our next report. We wish you success in this new year, and good investments.