Here are the most important and critical themes for 2014:
The US stock market continues its bull run
RBA continues to believe that the US stock market may be in the midst of one of the biggest bull markets of our careers. “It seems odd to us that investors seem to disregard the existence of a stock market cycle despite that the rotations and leadership in the US market have followed the normal historical pattern, Richard Bernstein says.
Indicators that have historically been reliable forecasters of bear markets still seem quite benign, Bernstein says. The yield curve remains positively sloped, valuation appears normal for this point in the cycle, and sentiment remains very attractive according to our models.
Japan outperforms emerging markets
According to RBA Japan is likely to outperform emerging markets again during 2014. bullishness on Japan in 2013 was based on a falling Yen, and Japan may be the first country to recognize that countries must compete on price (i.e., depreciating currency) in the absence of improving demographics and productivity.
Although RBA believes that investors have yet to fully recognize the significant structural headwinds facing the emerging markets.
European small cap stocks lead global equity performance
The European economic recovery has lagged the US during this cycle, which is typical by historical standards, Bernstain says. Smaller capitalization stocks tend to lead markets during most early-cycle periods. In addition, smaller capitalization European stocks currently have the world’s strongest 12-month earnings growth forecast.
High yield municipals lead the bond market
“Municipal finances are generally getting stronger. Investors also seem very concerned that interest rates will rise, but an increase in interest rates can actually improve pension funding status (the present value of future liabilities shrinks as interest rates rise)”, Bernstein says. Because of such factors, high yield municipal bonds might lead bond market performance during 2014.
Gold falls below $1,000
Gold is a hedge against inflation, and history suggests that abnormally high inflation rates are often stimulated by strong credit growth. “However, the global credit bubble is deflating, and developed economies’ inflation rates continue to fall without credit’s fuel.”
Therefore, gold will continue its bear market, and could fall below $1,000/oz, Bernstein estimates.
The American Industrial Renaissance continues
Smaller, domestically-focused US industrial and manufacturing companies have been gaining market share, and we think that trend is likely to continue. According to RBA Energy costs, productivity, transportation costs, quality control, political stability, and labor costs are some of the contributing factors. Despite the significant outperformance of these small and mid-cap companies in 2013, RBA expects small-caps to outperform again in 2014.
The Fed stays on hold much longer than investors expect
“Contrary to popular belief, the Fed has historically been a lagging, not a leading, indicator. The Fed has said that policy changes will be “data dependent” during this cycle (what exactly were they in past cycles if not data dependent?), and we interpret that to mean that Fed policy changes may lag more than they did in previous cycles.”
Because of the lagging Fed policy change, the stock market valuations could be higher and volatility could be lower than investors currently expect.
Investors realize that the term “Liquid Alts” may be an oxymoron
Ongoing fears of replaying 2008’s bear market suggests that investors may be paying too much for liquidity, and that liquid alternatives’ returns could be inferior to those of plain old-fashioned stocks, Bernstein says.
High quality stocks underperform
According to Bernstein, there is substantial evidence that “bad” companies have historically tended to make “good” investments over the long-term. “Much like in #7 and #8 above, 2008’s lingering fears have led investors toward more conservative, higher quality stocks. We think that trend might reverse during 2014.”
The expansion of bank balance sheets was the capacity created during the credit bubble. According to Bernstein, larger banks’ balance sheets ballooned during the credit bubble, but their balance sheets have yet to fully contract. Smaller bank balance sheets seem much better aligned to the post-bubble credit world. RBA expects smaller banks to again outperform larger banks in 2014.