Forecasting 2014: Looking for Potential Areas of Trouble

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On Friday afternoon, I was a guest on "The Trader's Network," a Dallas-area business talk radio show, hosted by Michael Yorba. Inevitably, because of the timing, we spent some time looking at the year to come and it occurred to me that I had done very little of that before then. As I contemplated this, I realized that part of the reason was that I had little interest in painting a sensational picture of the prospects for 2014.

In the financial media business, in fact in any media business in the modern world, consensus and moderation is considered bad. In the short term it is hard to drive page hits by saying that next year will see an average increase in corporate earnings and some moderate expansion in multiples leading to gains of around 10-15% in equity markets over the year, a gradual increase in interest rates, and relatively stable commodity prices... boring!

As unsexy as it may be, that is what I believe this year will be about, though, and one thing I have learned over the year of contributing to this site is that it is generally a good idea to treat Nasdaq.com readers as adults. "Fear sells" is an old cliché, and may be true in some areas but simply by being here, you, dear reader, have shown some discernment and a preference for substance over style, so let's look at the substance first.

The US economy is improving gradually but long term unemployment, low consumer confidence (and therefore spending) and a lack of investment have been serious drags in 2013. I am inclined to believe that all of these problems are structural in nature and will remain with us next year. An aging population, globalization and automation all play a part in long term unemployment and none of those things are going away.

Consumer spending and business investment are recovering, but slowly. This IMF study (PDF) shows that financial crises produce longer recessions and slower recoveries than anything else, so, while there were encouraging signs in consumer durables at the end of this year, it is no surprise that there is still some de-leveraging by the consumer. That isn't over and ultimately investment is driven by demand, or at least the prospect of it.

So, if nothing much looks set to change next year and the stock market is up around 30% this year, why not the same again? Because of two words... The Fed. We know what the exit from QE will look like; it will, at least at first, be in baby steps, but it has begun. I spent most of last year advising readers to overcome their fear and believe in the market because $85 billion per month provides a lot of support. In 2014, however, we will be back to fundamentals and (thankfully) there is little chance of 30% growth in the US economy.

As you can see, there are sound reasons why I and other commentators are predicting a somewhat boring grind through 2014 but I'm sure many of you have a nagging voice in your head saying "We've heard this before, but something unexpected will come along and mess it up..." It could; but these unexpected events are, as I've said before, known as "black swans" because they are unpredictable and rare, so attempting to predict one would be pointless and, quite frankly, silly.

That said, however, the expected 10% growth in stocks next year won't come in a straight line so some negative influences are to be expected. When I am considering what these may be, my contrarian nature makes me look in areas of buoyancy rather than in areas that have shown weakness already. Continued weakness in emerging markets, for example, could happen, but is to some extent priced in, so any reaction will be muted.

I believe there are two areas where pricing has got a little ahead of itself and either one or both could produce mini-collapses in the next year. At the very least, both should be watched closely.

Europe: There has been much talk of a strong European recovery in the second half of 2013. The Vanguard FTSE Europe ETF (VGK) for example, is up over 21% since the end of June. I just doubt how strong that recovery really is. After five years in the doldrums, some kind of positive move is to be expected, but the Euro zone still looks like a tale of two halves to me. While the successful economies, Germany et al, are picking up speed the southern countries that were the source of the problems still face the same challenges. Spain and Greece both have unemployment rates over 25%. Call me old fashioned, but that doesn't look like much of a recovery to me. It is hard to escape the feeling that some kind of shock could come from the area, but how do you spot it?

In my experience, foreign exchange markets frequently lead others in signaling trouble, so I will be keeping an eye on the Euro index. Any sustained move down will be a signal to take some money off the table, just in case.

Social Media: Some of my fears about this area were laid out in this article, but if anything they have increased. It started with the owners of Snapchat, a business that has never made a profit, in fact has never even brought in a dollar in revenue, turning down a $3 billion+ offer for the business...hmm!

Twitter (TWTR), looked overvalued to me at $40, so the rapid fall from $75 over the last few days is no surprise, but may be a sign of things to come. Those of us who were around in the late nineties have seen all this before. One day, some social media companies, like some dotcoms, will make a lot of money, but that doesn't mean that all of them are worth billions of dollars.

That rapid recent drop in TWTR suggests that reality could intrude sooner rather than later, so I will be keeping a wary eye on the sector. Ironically, if there is a bursting bubble scenario, it is likely to result in some great value in other areas of technology. Apple (AAPL), for example looks like value here as growth resumes, but if it is dragged down by a collapse in overvalued social media stock it may be an absolute steal.

In general, I am positive for 2014. Stocks will probably have a decent year and, while bonds will come under some pressure, it seems that the exit will be orderly. That doesn't mean, however, that there are no dark clouds in front of the silver lining. Both Europe and social media stocks have the capacity to provide shocks in the coming year. Keeping an eye on both of them may be a good idea.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Investing Ideas , Stocks , US Markets

Referenced Stocks: AAPL , TWTR , VGK

Martin Tillier


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