2014 Outlook: Validating the Rally

Transcription

1 2014 Outlook: Validating the Rally Presented to the Economic Development Council of Seattle and King County Michael Dueker, Chief Economist, Russell Investments JANUARY 16,

2 2014 outlook in brief Validating the rally Like early a mid-cycle acceleration in the economy Recession risk likely to remain low More jobs in our outlook relative to consensus Inflation likely to remain on sidelines Cyclical rebound in labor-force participation Bond yields to rise gradually to 3.4 for 10-year Treasury by end of 2014 Europe likely to remain in muddle-through mode---spain s 10-year bond yield is down to 3.81 percent as of Jan. 10, 2014; was above 5 percent on June 24, p.2

3 Highlights from last year s outlook Modest recovery proceeds with growth near 2.0 pct. Modest recovery proceeds with U.S. growth near 2.0 percent Equity markets have greater upside potential than economic growth Bond markets in the core sell off mildly as U.S. growth is not derailed; 2.15 percent U.S. 10-year Treasury yield at end of 2013 p.3

4 Russell s 2014 global economic outlook Synchronized uptick in the global economy UNITED STATES Validating the rally EUROZONE Skating on thin ice Asia Meeting expectations Expect 2.9% real GDP growth Modest inflation 1.9% Stabilization of housing Above-consensus employment gains projected (+230k / mo.) Expect 0.5%-1% Eurozone GDP growth Gradual and modest recovery in demand Reduced austerity Concern about banks Expect 7%-8% GDP growth in China Expect 1.6% GDP growth in Japan 1 Consensus is represented by Blue Chip consensus forecasts as of December Each month since 1976, Blue Chip Economic Indicators has polled 50 of America s top business economists, collecting their forecasts of U.S. economic growth, inflation, interest rates, and a host of other critical indicators of future business activity. p.4

5 Why did stock prices rise 30 percent last year as economic growth hovered just below 2 percent? Modest recovery proceeds with growth near 2.0 pct. It was largely a re-pricing event After the Great Recession, a frequent claim was that recessions would be more frequent this decade due to the economy remaining near stall speed A few missed strokes in the economy s motor can cause a decrease below stall speed This claim proved to be false and was based on the wrong metaphor p.5

6 Stall speed, schmaltz speed Recessions are like shifts in gear and such shifts are not more likely just because the cruising speed is lower Markets began to perceive lower recession risks last year Stepped off risk-on/risk-off pendulum driven by recession concerns secondarystalls.html&h=666&w=1404&sz=72&tbnid=qfrjx22_se7vym:&tbnh=90&tbnw=190&zoom=1&usg= f0qzqezd3r5gevsxdxsu4xfs8pi=&docid=kmhg7s00sd9rxm&sa= X&ei=KkLTUq7WCI_zoATgkIDICA&ved=0CDEQ9QEwAQ p.6

7 Summary of quantitative model signals for Dynamic vs Defensive equities Six-month summary statistics December 2013 reading vs. November 2013 reading Outright bearish Moderately bearish Mildly bearish Neutral Mildly bullish Moderately bullish Outright bullish Dynamic-Defensive Model Key December 2013 reading November 2013 reading Source: Russell Investments. As of 12/15/13. There is no guarantee that any stated expectations will occur. Forecasting or other forward-looking information is inherently uncertain and may be incorrect. It is not representative of a projection of the stock market, or of any specific investment. p.7

8 Threshold model view of Russell 1000 Index valuation gap 30 Model-implied valuation gap (in percent) R1000 val. gap Jun-87 Mar-88 Dec-88 Sep-89 Jun-90 Mar-91 Dec-91 Sep-92 Jun-93 Mar-94 Dec-94 Sep-95 Jun-96 Mar-97 Dec-97 Sep-98 Jun-99 Mar-00 Dec-00 Sep-01 Jun-02 Mar-03 Dec-03 Sep-04 Jun-05 Mar-06 Dec-06 Sep-07 Jun-08 Mar-09 Dec-09 Sep-10 Jun-11 Mar-12 Dec-12 Sep-13 Source: Russell Investments. Based on a statistical model whose inputs include the Russell 1000 Index returns, the Business Cycle Index and the slope of the yield curve. Models have many inherent limitations and may not reflect the impact of material economic and market factors. p.8

9 US BCI forecasts give a very constructive view of U.S. economy in 2014 with low inflation 3 2 Business cycle index as of December 2013 data Out of sample forecasts were calculated by simulating the time-series model into the future. The value shown is the median of the simulated value for the month. Source: Recession data from National Bureau of Economic Research YELLOW BARS INDICATE PERIODS OF RECESSION sample st. devs. from zero Source: Recession dates from National Bureau of Economic Research. Out of sample forecasts were calculated by simulating the time-series model into the future. The value shown is the median of the simulated value for the month. There is no guarantee that any stated expectations will occur. Forecasting or other forward-looking information is inherently uncertain and may be incorrect. These views are subject to change at any time without notice based upon market or other conditions and are current as of 12/15/ p.9

10 BCI model points to above-consensus jobs gains in 2014 (230k vs. 198k per month) 400 Forecasts of nonfarm payroll employment changes as of December 2013 data Source: Actual employment data from St. Louis Fed's FRED database 200 thousands of jobs Source: Actual employment data from St. Louis Fed s FRED database. There is no guarantee that any stated expectations will occur. Forecasting or other forward-looking information is inherently uncertain and may be incorrect. These views are subject to change at any time without notice based upon market or other conditions and are current as of 12/15/ p.10

11 Forecasts for real GDP growth: Blue Chip consensus and Russell's forecast Annualized growth (%) Q4 2014Q1 2014Q2 2014Q3 2014Q4 2015Q1 2015Q2 2015Q3 2015Q4 Russell Blue Chip As of January 10, 2014, issue of Blue Chip Economic Indicators p.11

12 Forecasts for CPI inflation: Blue Chip consensus and Russell's forecast Annualized growth (%) Q4 2014Q1 2014Q2 2014Q3 2014Q4 2015Q1 2015Q2 2015Q3 2015Q4 Russell Blue Chip As of January 10, 2014, issue of Blue Chip Economic Indicators p.12

13 Tree-chopping analogy How should we judge the Fed s third round of Quantitative Easing now that it is in the tapering phase? Think of a tree-chopping analogy. If one has taken two swings at a tree with an axe, the third is the one that might make the tree fall. In fact, nominal GDP growth in 2014 is projected to reach 4.8 percent finally! 13

14 Forecasts for unemployment rate: Blue Chip consensus and Russell's forecast 7.2 Unemployment forecast Russell Blue Chip Q1 2014Q2 2014Q3 2014Q4 2015Q1 2015Q2 2015Q3 2015Q4 As of January 10, 2014, issue of Blue Chip Economic Indicators p.14

15 Important Information and Disclosures Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. The general information contained in this publication should not be acted upon without obtaining specific legal, tax, and investment advice from a licensed professional. Please remember that all investments carry some level of risk, including the potential loss of principal invested. They do not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns.\ Diversification and strategic asset allocation do not assure profit or protect against loss in declining markets. Forecasting represents predictions of market prices and/or volume patterns utilizing varying analytical data. It is not representative of a projection of the stock market, or of any specific investment. Bond investors should carefully consider risks such as interest rate, credit, repurchase and reverse purchase transaction risks. Greater risk, such as increased volatility, limited liquidity, prepayment, non-payment and increased default risk, is inherent in portfolios that invest in high yield bonds or mortgage backed securities. Indexes are unmanaged and cannot be invested in directly. Past performance is not indicative of future results. Copyright Russell Investments All rights reserved. This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an as is basis without warranty. Russell Investment Group is a Washington, USA corporation, which operates through subsidiaries worldwide, including Russell Investments, and is a subsidiary of The Northwestern Mutual Life Insurance Company. The Russell logo is a trademark and service mark of Russell Investments. Date of first use: January 2014 CORP-9170 This presentation was created for informational purposes only and is not meant for further distribution. 15