I just re-read yesterday's Market Musings column and realized that it came out a lot more negative than I intended. As I said, I do think that both Europe and social media stocks are a little frothy and either or both could fuel a correction in the market at some point next year, but overall, believe it or not, I’m positive for the reasons I laid out in that piece and others. Economic conditions in the US are improving, politicians here have begun to show signs of intelligent life, Chinese growth, while slower than some would like, will continue, etc.
I laid that out, but didn't make it clear where I thought growth would come from, so here goes.
After five years of de-leveraging, there are signs that the US consumer is beginning to loosen the purse strings somewhat.
As this US Bureau of Economic Analysis chart shows, spending has been increasing consistently since the beginning of 2010 and Q3 of 2013 kept that intact. Digging deeper into the numbers suggests that large purchases, consumer durables such as cars and appliances, are leading the way. This is hardly surprising given weak demand for a number of years, but once those demands are met more discretionary spending is the logical next step. Continued gains in the SPDR Consumer Discretionary ETF (XLY), therefore, would come as no surprise.
If that comes then retail, a sector that has come under some pressure with indications of slightly disappointing Holiday numbers, could end up having a good year. Big purchases should continue too, and, as I said here, the US auto industry could have a banner year, so both GM (GM) and Ford (F) would be in my top picks.
The year also looks to be setting up nicely for financials as a sector. Big banks have continued to disappoint as the recovery has progressed, but that could change. As the Dodd-Frank regulations, and particularly the "Volcker Rule" aspects have been clarified, a major area of uncertainty for banks has been removed. Restrictions on proprietary trading will no doubt hurt profits in the short term, but financial companies will simply look to replace those profits, and the associated risk, elsewhere.
As shocking as it sounds, we could be entering a period when banks make money from that most traditional of sources, making loans! The continued reduction in QE will leave them with less cash to throw around, but gradually rising interest rates will make lending out what they do have more attractive. Ironically, the relatively flat yield curve and ultra-low rates that we have seen may now be beginning to restrict rather than encourage spending. For a bank, lending is a risk/reward calculation and low interest rates equate to a low reward, discouraging taking a risk. As that situation changes, more, rather than less, bank lending could result.
Obviously, a consumer with an increasing appetite for spending and banks with more incentive to make loans are complimentary scenarios and any effect could be multiplied. For that reason, I favor banks with a lot of direct consumer exposure, such as Bank of America (BAC), Citi (C) and JP Morgan Chase (JPM) over the next 12 months.
If both banks and consumer discretionary do well next year, then everything will. Strong demand and a willingness to lend are the most basic building blocks of the economy, so, barring any real shock from the areas I mentioned yesterday, the 10-15% appreciation that is the consensus could look silly; another 30% year is not out of the question.
In that case I'm sure that most will have a prosperous New Year, but I also hope that 2014 sees you happy and healthy as well. Thanks for reading and commenting in 2013 and I look forward to another year of musing on the markets.