Bob Doll, Nuveen Investments’ chief equity strategist and senior portfolio manager, expects broader and strong but still moderate economic growth in the U.S. and globally in 2014.
Speaking Tuesday at a news briefing in New York about his yearly predictions, Doll said his overarching theme this year was “less fear, more confidence.” Doll said he expected bond yields to continue to rise gradually as the Federal Reserve’s tapering moves ahead slowly and incrementally.
He noted that improving economies were leading to lower macroeconomic risks. Fiscal drag is lessening in the U.S., Europe is coming out of recession, Japan’s deflationary headwinds are diminishing and China appears to be stabilizing. “In the U.S., better business sentiment on top of firming consumption will likely enhance the odds of a noticeable increase in capital spending enabling a somewhat stronger growth trajectory,” Doll said. “The transition to self-sustaining growth will provide a much needed acceleration in revenue and earnings growth.”
He noted that many doubted the durability of the equity rally, arguing that stocks had become expensive and profit margins unsustainably high. Those factors could limit gains, he said, but would not prevent them. The stock market has outperformed, he said, because "corporate America is delivering the goods; they're called earnings." Stocks may be more volatile than they were last year, but his recommended allocation remains to overweight stocks.
“While stocks are vulnerable to a correction any time given their recent strength and some technical deterioration, we continue to favor a moderate pro-growth posture with forward long-term potential and mid- to high- single-digit annual percentage gains,” Doll said. In 2014, he said, Nuveen prefers companies with positive free cash flow profiles, low valuations, economic sensitivity and /or above average secular growth.
The biggest themes for the United States this year, he said, will be the economic recovery, Obamacare, further fiscal restraint, loss of global prestige and the midterm elections in November. He called it an 80% probability that the Democrats would retain power in the Senate and the Republicans in the House, though the GOP will likely pick up some seats in both chambers (see prediction 10 below). Globally, cyclical issues "have interrupted, not ended, the shift of economic power and financial wealth" from the developed to the emerging world.
Following are Doll’s 10 predictions for the economy in 2014.
1. The U.S. economy grows 3% as housing starts surpass 1 million and private employment hits an all-time high
The economic recovery that began in mid-2009 will likely show some broader and stronger growth in 2014 after several false starts. Hopeful signs abound: the housing recovery, falling oil prices, acceptable job growth, easing lending standards, low inflation, record high net worth, rising capital expenditures, less fiscal drag and improving non-U.S. growth. Private employment, Doll said, would reach an “all-time high.”
2. 10-year Treasury yields move toward 3.5% as the Federal Reserve completes tapering and holds the short-term rate near zero
Doll said he expected the bear market in bonds that started about 18 months ago to continue as interest rates slowly normalized. A big question for the bond market, as well as for the economy and markets generally, is the inflation rate. Doll said that although a big rise in inflation was unlikely, it would probably be clear by year-end that inflation had reached a bottom.
3. U.S. equities record another good year despite enduring a 10% correction
Doll said expectations of high single-digit or low double-digit percentage gains were reasonable, but added that a 10% correction during the year is likely to be caused by overbought and deteriorating technical conditions. “A 10% correction is normal,” he said.
4. Cyclical stocks outperform defensive stocks
Doll said he expected cyclicals to outperform in 2014, reversing the recent trend of defensive stock leadership. He pointed to stronger U.S. economic growth, a rise in capital expectations and some improvement in non-U.S. economies. Over all, he expects corporate profit margins in 2014 to be flat, and he doesn't expect real wage gains.
5. Dividends, stock buybacks, capital expenditure and M&A all increase at a double-digit rate
Corporate America has a lot of cash flow, and many companies have underleveraged balance sheets. Dividends and buybacks have been increasing in recent years, Doll said. Now he expects the largesse to spread to business reinvestment and acquisitions. Pent-up demand and aging of plants, equipment and technology argue for increases in those key areas.
The U.S. is rapidly moving toward energy independence, and this is already positively influencing the country’s trade deficit and promises to enhance U.S. job expansion and economic growth, Doll said. Moreover, the increasing desire by U.S. and non-U.S. companies to manufacture in the U.S. has a similar salutary effect on the dollar. Both energy and manufacturing, he said, will have equally important effects on the dollar.
7. Gold falls for the second year and commodity prices languish
Gold had a good bull run, trading above $1,500 an ounce for a while even after concerns about the financial system’s viability and inflation went unrealized. The precious metal ran out of steam in 2013, and will remain under pressure this year from improving global growth and reduction in systemic threats, some rise in real interest rates and likely dollar improvement. "My guess," Doll said, "is that we haven't seen the bottom for gold." The Fed's QE, which helped prevent both deflation and inflation, also affected gold in 2013.
On commodities, a lack of strong global demand and abundant supply for many commodities portends trendless but volatile commodity prices in the new year.
8. Municipal bonds, led by high yield, outperform taxable bond counterparts
The fundamentals are mixed, but Doll contended that the pricing of municipal securities relative to taxable fixed income securities took that into account, and the tax-exempt market is positioned for outperformance. "Munis are cheap comparable to Treasuries," he said.
Detroit’s and Puerto Rico’s widely publicized difficulties have created an opportunity for municipal bond investors, Doll said. The fall of 2013 signaled a "turning point for state and local governments," as both government and unions began to agree to some capping of pension benefits, which he called "a big change in munis." In addition, state and local government receipt and outlay patterns are improving.
9. Active managers outperform index funds
When asked if active managers had become more intelligent, Doll said "we've got the same IQ as we always had." Instead, the broadening of the equity market and reductions of correlations may increase the ability of active managers to outperform benchmarks. As well, he said there were "fewer active players mining for a larger pool of alpha."
10. Republicans increase their lead in the House, but fall short of capturing the Senate
Doll predicted that in the November midterm elections, Republicans would increase their 234-seat majority in the House, picking up between four and six seats. However, their campaign to win a majority in the Senate would fall short, as they are most likely to add three or four seats to their current 45.
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