There is little evidence that the fiscal follies of Sept./Oct. have slowed the US economy. We believe growth is likely to pick up to a 3-3½% pace in 2014, for three main reasons:
- The decline in federal spending is likely to slow sharply.
- We expect a meaningful acceleration in consumer spending.
- We expect capital spending growth to pick up substantially from the pace seen over the past four quarters.
Consumer Price Index (CPI) inflation is currently running at 1.7%. We expect inflation to stay near these low levels throughout 2014. In terms of valuations, the S&P 500 is currently trading at 15X forward earnings. Stock market increases have been driven primarily by Price Earnings (P/E) expansion this year. In our view, stocks are fairly valued at the current levels. It is our view that in order for stock prices to move higher that we are going to need to see earnings growth. Our research suggests that Technology and Energy are trading at the largest discount.
We continue to favor growth over value and are maintaining our higher allocations to the small/midcap space. We believe that developed International markets are becoming more attractive, including Europe. Expectations are very low, with the European Central Bank lowering rates to stimulate growth. That being said, not all companies and industries are on solid footing which is why we recommend active over passive management in this space. We expect the rally to continue and expect we will see 1825 by years end on the S&P 500 and 1900 to be reached in 2014. We also think that the probability of a more significant pullback is rising as the taper appears to be getting pushed out. The Taper of assets is our greatest concern in the short term and we believe this action has the potential to cause a 5-7% pullback in the market. Our view of this potential pullback is that it would be short lived and should be viewed as a buying opportunity.
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