Allen Sinai, PhD
Allen Sinai, PhD, CEO and chief global economist at Decision Economics, Inc., a financial advisory firm based in Boston and New York City. He has been an adviser to several US presidential administrations. DecisionEconomicsInc.com
The stock market had a difficult time getting unstuck through the first few months of 2014. But top economist and regular Bottom Line/Personal contributor Allen Sinai rejects the notion held by many analysts that the long-running bull market is experiencing its last gasps.
Sinai told us that many investors are underestimating the gathering strength of the US economy and that bailing out of the market now is premature.
In his view, the market was just catching its breath in early 2014 after last year’s huge advance. Stocks can continue to climb, albeit at a much more modest pace, and rise by about 11% for all of 2014 and a total of about 30% from the beginning of this year until the bull market ends, possibly in 2016.
Here is what Sinai forecasts for the rest of this year and beyond…
It’s not surprising that investors were taking a wait-and-see approach in early 2014. Last year’s extraordinary 32% gain for the Standard & Poor’s 500 stock index was a big bet on stronger growth for US and global economies and corporate profits. Ultimately, I think growth will speed up. My reasoning: The conditions still are ripe for continuing economic expansion.
There are no signs of the fast-rising consumer prices that tend to characterize the later stages of an economic expansion and bull market. At the same time, the economy is no longer hamstrung by a debt crisis, a recession in Europe or battles in Washington, DC, over federal spending and tax policies that left companies uncertain about where things were headed and reluctant to ratchet up their spending.
Investors unwilling to settle for paltry yields from bonds and savings have continued to pour money into the stock market. US stock mutual funds saw net inflows of $25 billion in the first four months of 2014, the strongest start of a year since 2004. And even though the Federal Reserve is winding down its bond-buying program, which was meant to stimulate economic growth, the Fed doesn’t expect to start increasing short-term interest rates until the second half of 2015.
Although the US unemployment rate still is high and many frustrated people have dropped out of the labor force, the fact that the rate dropped from 6.7% in March to 6.3% in April—the biggest one-month decline in 31 years—is a strong positive sign. As job growth returns, consumers will feel more secure and consumer spending will increase.
We don’t need robust, 4%-to-5% annual growth in the US gross domestic product (GDP) to keep the bull market going. In fact, we haven’t experienced that level of growth since the late 1990s. I believe that growth far less than 4% will be normal for us in economic expansions for some time. That’s because we are undergoing a tectonic shift in the global economic landscape. Emerging markets will become wealthier, and developed nations such as the US, burdened by huge debts, will see their economic potential diminished.
Large companies have learned how to grow their earnings and profits in a slower economy. This year, economic growth just needs to climb by a somewhat healthier pace for stocks to thrive. By healthier, I mean nearer the long-term historical average of 2.5%-to-3% annual GDP growth (compared with 1.9% in 2013), which I believe is attainable.
While stocks have soared since April 2009, valuations currently are reasonable. For example, the share prices of S&P 500 stocks were recently 16 times their estimated earnings per share for the next 12 months, on average. That price-to-earnings ratio (P/E) is just slightly above the long-term historical average.
I expect the current up cycle in the stock market to last into 2016, and before it is over, we can reach 2,300 to 2,400 in the S&P 500 and 21,000 or 22,000 in the Dow Jones industrial average.
However, I do expect a major but temporary pullback in late 2014 or early 2015 as the likelihood of an increase in interest rates grows stronger and investors worry that higher rates will slow the economy. Even in the face of a big stock market correction—a pullback of at least 10% to as much as 20%—investors would be wise not to dump stocks. Indeed, they would be wise to buy on weakness. That’s because by then, the forces that bring about higher interest rates, including a stronger economy and higher inflation, also will be pushing up company revenues and earnings and support higher stock prices.
Here’s what I expect for the rest of this year and beyond…
GDP. Frigid temperatures and a stubbornly long winter in parts of the US hurt the economy in the first quarter of 2014. But momentum is rising. I expect growth to be in the 2.5%-to-2.75% range for 2014 (the strongest expansion since 2005), spurred by consumer spending, and in the 3%-to-3.5% range in 2015, compared with an average of about 2% a year since 2009.
Unemployment. The economy is creating jobs at a quickening pace, an average of 214,000 a month this year through April, which is ahead of last year’s pace of 194,000. I expect the unemployment rate to drop to 5.9% by the end of 2014. As measured by the Consumer Price Index (including food and energy), inflation is likely to tick up in response to stronger economic growth by the end of 2014, running at about 1.8%, which still is below the 2% level that the Fed is comfortable with. In 2015, inflation will likely top 2%.
I’m forecasting that the S&P 500 will rise to 2,050 by the end of 2014, up about 11% for the year. The Dow should hit 18,500 for a similar gain.
Best sectors of the stock market now…
Consumer discretionary. Family-oriented leisure-time subsectors such as restaurants, movies and entertainment and Internet retail look especially attractive.
Health care. Medical breakthroughs and Obamacare enrollees will benefit companies providing health-care equipment and pharmaceuticals.
European stocks. Despite an anemic recovery in much of Europe, European stocks are likely to gain strength. That’s because shares of world-class companies there are still a relative bargain…inflation remains almost nonexistent…and the European Central Bank is trying to revitalize economic growth with measures such as cutting interest rates.
I continue to be unenthusiastic about the potential returns for corporate bonds and US Treasuries compared with stocks. By the end of this year, the 10-year Treasury likely will yield about 3%, compared with the recent 2.5%.
I expect total returns for bonds to be 2% to 3% for 2014. You should keep the average maturity of your bond holdings to less than 10 years.
