The markets have turned down recently due to disappointing global growth news. Our biggest concern is a downturn in the German economy. Germany has been a stalwart within the European Union. A slowdown in that part of the region may mean a double-dip recession. We are not convinced of that reality just yet.
We are monitoring another possible threat of deflation. Deflation is an economic scenario where we experience falling prices. On the surface it may seem like a positive, but it is hard to fight deflation as it is typically caused by lower economic demand. We are watching this trend particularly in Europe and China.
Technically, the market has broken a pretty significant up-trend line. This leads us to believe the most recent drawdown may last longer than the other four or five short-term corrections we have experienced in the last twelve months. In reality, surprisingly, we have not seen a 10% correction in the markets since 2011. A correction is due. We do not believe this market correction will lead to a new bear market. However, it will probably be longer in nature and a bit deeper than what we have recently experienced. That said, we are confident that the markets will eventually trade at higher prices and we are looking for sector rotations that we can capitalize on during this time frame.
The year 2013 was great for stocks, however, valuations also rose considerably and a sense of over optimism crept into markets in the run up to the New Year. The current, more volatile market backdrop is a timely reminder to investors that equity valuations have come a long way in the last 18 months and as a consequence they are more susceptible to macro or stock-specific disappointments.
Global growth is showing signs of a recovery, with GDP expectations edging up. This recovery is being led by the developed world as the impact of fiscal consolidation in the US wanes, while the UK and pockets of the Eurozone begin to recover. In contrast, emerging market economies and those most closely linked with the previous rapid expansion in China are showing signs of slowing further. This pattern is likely to continue in the short term as western Central Banks maintain accommodative monetary policy, and China begins to curb its reliance on excessive credit consumption.
The good news is that many experts believe that we have a few more years left in this economic expansion. It will likely be a long time before the Fed has to react to quell inflation. There is a lot of cash on the sidelines. Individual and Institutional Investors have trillions in cash that never went back into the market after the 2008 – 2009 market down turn. The view of our firm is that stocks remain fairly valued and that increases in earnings through 2014 will cause stocks to rise modestly for the year. For the fixed income allocation of our portfolios we expect pressure from rising rates to reduce the returns of typical bond holdings. For this reason, variable rate and alternative type bond funds are being used to provide the stabilizing component needed.