Editor’s Note: This is one in a series of periodic market watch articles provided by E. Dryden Pence III, whose investment advisory firm Pence Wealth Management has been recognized as one of the top in the United States byBarron’s, Forbes and The London Financial Times.
Bottom Line Up Front:
- We think the US stocks are currently in a secular bull market—meaning it has legs, not in months but years. We believe that continuing earnings growth and expansion in PE multiple will support future equity returns in this year and the next. When adjusted for inflation, we are still 10% below the 2000-peak despite being 117% above the March 2009 bottom (chart 1, below)
- We remain bullish on the US economy despite weather-related weaknesses in recent economic data. Housing, employment and consumer spending were affected by an unusual cold winter east of Mississippi. Although the unusual cold-winter will most likely lower the first quarter Gross Domestic Product (GDP) by a percentage point to 1.8%, we believe the economic growth will pick up for the rest of the year.
- We expect the US economy to grow about 3%, plus or minus 0.5% for the next three years. Main reasons for that:
- We are expecting reduced fiscal drag in 2014 and 2015 that will help GDP growth (chart 2, below)
- We see strong and steadyconsumer spending, which is 70% of the US GDP
- We expect corporate America to increaseCapex spending this year (chart 3, below). Since the recession,they have strengthened cash reserves and rewarded shareholders.Cash still represents close to 10 percent of the market value of members of the S&P 500 index.
- We believe a lowertrade deficit (a drag to GDP) will continue to improve as America’s dependence on foreign oil declines (chart 4, below)
The Way We See It:
So far, there have been two headlines affecting global markets:
- Russia invading Ukraine’s Crimea region and
- Extreme cold weather east of Mississippi
Why do we care about Russia? We care about Russia because of Europe. More than one third of the European Union’s energy comes from Russia. Only Denmark produces more than it consumes. Any threats to sanction energy supply will put EU’s fragile recovering-economy in jeopardy and will affect the rest of the global activity. Tighter U.S. and European sanctions to Russia will be tough to pull off. But if fully deployed, they could be very painful to Russia’s already weakening economy. Sanctions that have so far focused on individuals via visa bans and asset freezes may be expanded to target specific areas of the economy. Economic sanctions can push Russia toward a recession as the intensity of their economic penalties increases. A World Bank report on the Russian economy said that GDP could contract by as much as 1.8% in 2014 if the crisis persists. Banks including state-run VTB Capital say the world’s ninth-biggest economy will shrink for at least two quarters. The Economy Ministry has now estimated massive capital outflows from Russia at up to $70 billion in the first quarter; more than the $63 billion recorded in the whole of 2013.
Relentless winter weather from December 1 through February 28 has already taken a $5.3 billion toll on passengers, airlines and airports. One million flights have been cancelled or delayed, impacting 90 million passengers. In comparison, a typical winter has an average of $2.9 billion in economic impact and an average over the previous two winters of $1.5 billion. The Fed, in its anecdotal Beige Book report, also confirms weather-related drag on U.S. economy in early 2014. Abnormally cold weather probably slowed fourth-quarter growth by 0.4 points and is expected to shave a full percentage point from first-quarter GDP, according to an analysis from Macroeconomic Advisers in St. Louis. Most Fed officials believe that the recent soft data is more weather related and therefore will be short-lived than a fundamental slowdown. We also think this way.
 Source: according to the median forecast of economists surveyed by Bloomberg.
 Gross private domestic investment includes replacement purchases plus net additions to capital assets plus investments in inventories. Capital Expenditures (Capex): Funds used by a company to acquire or upgrade physical assets such as property, industrial buildings or equipment.
 Source: eurostat
 Source: masFlight, March 3, 2014
ABOUT THE AUTHOR
E. Dryden Pence III, CPM®, AIF® is an LPL Registered Principal and serves as the CIO of Pence Wealth Management. Under his leadership and investment direction the firm has grown to be one of the most respected wealth management firms in the nation with both the firm and its advisors frequently recognized by industry journals such as Forbes andBarron’s.
Dryden obtained his degree in Economics from Harvard University in 1982. His previous Investment Banking career spanned 22 years and over $1 billion in financial transactions. As a Colonel in the U.S. Army Reserves he commands the joint transformation command for intelligence. His specialty is Psychological Warfare and he has been decorated for valor in combat.
CA Insurance Lic.# 0F82198. E. Dryden Pence III is a registered principal with and securities offered through LPL Financial. Securities and Advisory Services offered through LPL Financial, a Registered Investment Advisor. Member FINRA/SIPC.