10 surprises for 2014

Markets are improving, but expect the unexpected over the coming year.

Summary: The US economy is continuing to improve, and expectations point to strong returns for investors in the year ahead. But there are bound to be some surprises for investors, including likely events that are on the radar screen and which have a good chance of coming to fruition.
Key take-out: Investors should expect more volatility, including the possibility of a sharp US market correction. But expect good overall returns by the end of the year.
Key beneficiaries: General investors. Category: Economics and investment strategy.

What’s in store for investors in 2014?

The year is barely underway, but opinion is still weighted towards another period of strong returns – particularly on most equities markets including the ASX.

Byron Wien, vice-chairman of Blackstone Advisory Partners, is a semi-regular contributor to Eureka Report, and last wrote for us about his perceptions on China’s economic health following a visit to the Asian region in mid-2013. At the time, he indicated that there were signs of weakness in the Chinese economy – an observation that has major ramifications for Australia.

For the past 29 years Byron has given his views on a number of economic, financial market and political “surprises” he expects in the coming year, most of which relate to the United States.

He defines a “surprise” as an event which the average investor would only assign a one out of three chance of taking place but which he believes is “probable,” having a better than 50% likelihood of happening.

Byron started the tradition in 1986 when he was the chief US investment strategist at Morgan Stanley.

Here is Byron’s list of 10 surprises for the 2014 year:

1. We experience a Dickensian market with the best of times and the worst of times. The worst comes first as geopolitical problems coupled with euphoric extremes lead to a sharp correction of more than 10%. The best then follows with a move to new highs as the Standard & Poor's 500 approaches a 20% total return by year end.

2. The US economy finally breaks out of its doldrums. Growth exceeds 3% and the unemployment rate moves toward 6%. Fed tapering proves to be a non-event.

3. The strength of the US economy relative to Europe and Japan allows the dollar to strengthen. It trades below $US1.25 against the euro and buys 120 yen.

4. Shinzo Abe is the only world leader who understands that Dick Cheney was right when he said that deficits don’t matter. He continues his aggressive fiscal and monetary expansion and the Nikkei 225 rises to 18,000 early in the year, but the increase in the sales tax, the ageing population and declining work force finally begin to take their toll and the market suffers a sharp (20%) correction in the second half.

5. China’s Third Plenum policies to rebalance the economy toward the consumer and away from a dependence on investment spending slow the growth rate to 6% in 2014. Chinese mainland traded equities have another disappointing year. The new leaders emphasise that their program is best for the country in the long run.

6. Emerging market investing continues to prove treacherous. Strong leadership and growth policies in Mexico and South Korea result in significant appreciation in their equities, but other emerging markets fail to follow their performance.

7. In spite of increased US production the price of West Texas Intermediate crude exceeds $US110. Demand from developing economies continues to outweigh conservation and reduced consumption in the developed world.

8. The rising standard of living and the shift to more consumer-oriented economies in the emerging markets result in a reversal of the decline in agricultural commodity prices. Corn goes to $US5.25 a bushel, wheat to $US7.50 and soybeans to $US16.00.

9. The strength in the US economy coupled with somewhat higher inflation causes the yield on the 10-year US Treasury to rise to 4%. Short-term rates stay near zero, but the increase in intermediate-term yields has a negative impact on housing and a positive effect on the dollar.

10. The Affordable Care Act has a remarkable turnaround. The computer access problems are significantly diminished and younger people begin signing up. Obama's approval rating rises and in the November elections the Democrats not only retain control of the Senate but even gain seats in the House.

Every year there are always a few surprises that do not make the 10, either because I do not think they are as relevant as those on the basic list or I am not comfortable with the idea that they are “probable.”

Also rans:

1. Through a combination of intelligence, extremism, celebrity and cunning Ted Cruz emerges as the clear front runner for the 2016 Republican presidential nomination. Chris Christie and the moderates fade in popularity as momentum builds for fiscal and social conservative policies.

2. In 2½ years the price of a Bitcoin has increased from $US25 to $US975. The supply of Bitcoins is fixed at 21 million with 11.5 million in circulation. Bitcoins lack gold’s position as a store of value over time. During the year Bitcoin’s acceptance collapses as investors realise that it cannot be used as collateral in financial transactions and its principal utility is for illegal business dealings where anonymity is important.

3. Overcoming objections from the Cuban exile community, President Obama opens discussions on initiating trade and diplomatic relations with Cuba. A reduction in sanctions is proposed, as well as limited financial support in the form of bonds, quickly dubbed as “Castro convertibles.”

4. Hillary Clinton decides not to run for President in 2016. She says her work with various Clinton non-for-profit initiatives is important and unfinished. Specifically, she explains that her health was not an issue in her decision. The Democratic race for the top seat becomes chaotic.

This is an edited version of an article by Byron Wien. As vice-chairman of Blackstone Advisory Partners, he acts as a senior adviser to both the firm and its clients in analysing economic, social and political trends to assess the direction of financial markets and thus help guide investment and strategic decisions.