What to expect in 2014

At times it seems like being invested in today’s stock market is like playing a ‘scratch n win’ lottery ticket:   An investor might believe they are close to winning, when in reality the end result has been predetermined.

In 2012, the financial crisis of 2009 was still fresh in our minds.  The European crisis was just getting started, and markets were volatile.

In 2013, Europe stabilized.  Greece nearly collapsed and left the EU, but the market moved on (even under the new precedence of using bank depositor cash to save the country).  The U.S. Government even shut down for awhile, but the market played onward and upward.

If you were a short seller in 2012 and, especially 2013, you got your clock cleaned.  It didn’t matter that all the news and evidence and statistics supported your position, markets were going up with or without your approval.

10 or 15 years ago, the bears might have been right about the negative fundamentals and their effect on the market, but in today’s centrally-planned global economy it’s a different game.  So what has changed since then?

The world sings in perfect harmony

U.S. assets owned abroad (click to enlarge)

For starters, markets are more global than they were back then.  In 2000, foreign investment in U.S. assets was $6 billion.  Today it’s $23 billion and growing (the U.S. owns more foreign assets than that).

As a result, markets are more correlated than ever before (see chart).

Markets are more correlated than ever before (click chart to enlarge)

It used to be that investing in the S&P was a bet on U.S. Growth.  Not so today:  many of the companies on the S&P are multinational corporations like Apple, IBM, and now Facebook which deal in multiple foreign currencies, making the S&P a type of currency hedge tied to the rise and fall of other global currencies.

In late 2012, U.S. markets were seen as the ‘cleanest dirty shirt’ on an international stage, attracting global capital that would have otherwise been placed in higher risk emerging markets (this is the ‘jobless recovery’ we keep hearing about).

Exacerbating this rise is 5 years of nearly zero interest rates thanks to 3 rounds of Quantitative Easing, which has given foreign and US investors alike a lot of incentive to chase yield and beta in the markets rather than having it eaten away in a savings account (interest rate – inflation rate = money lost).   Price to Earnings ratios on the S&P have reached a higher level higher today than they were in 2007… It’s not that companies are necessarily doing well, they’re just not doing quite as bad, and this is good enough for investors.

Finally, cheap credit has given companies a lot of incentive to borrow money and either buy back their own shares or pay a dividend to their shareholders, or both,  and all of this is net positive for stock prices.

There are other factors at play in the current bull run, such as a generation of newly minted investors embarking on their careers, a corresponding wealth effect due to QE, a currency war, and a tantalizing bond bubble just waiting to burst, but our point is this:  Global capital currents are pushing the U.S. stock market in one direction, and that is up.

Capitalizing on capital flows

In our view, the (really) easy money is over.  2013 was the year to front-run this massive shift into U.S. equities, and the market responded in spades.  You could have thrown darts at an index of stocks and done quite well (unless you were a hedge fund).  But after a 30% return in 2013, what does the market do for an encore?

If the S&P were to rise another 30% this year not only would this be a miracle, but P/E multiples would be at dangerous nosebleed levels and we’d all be in trouble.   An more reasonable 10% gain this year would get us to 2,000 on the index – a nice round number, and an area many analysts are calling for.

To achieve a return of any more than that in 2014 will require a little more discriminate stock picking, and that’s where our algorithmic research comes into play.

This year we continue to track asset allocation trends via quantitative analysis of the holdings of the largest mutual and hedge funds in existence, with combined assets under management of over $2 trillion:

These behemoths have the ability to move markets world wide.   Since smaller investors like us simply go along for the ride, it’s always best to keep tabs on their positions.

Their holdings represent a universe of over 3,000 securities which will be the starting point for our algorithmic scans in 2014.   In the days to come we will be narrowing these down and categorizing to get a complete picture of where to be invested, after which our algorithms take over and select the ones which have the highest probability historical trading patterns.

Stay tuned – this is going to be a very good year.  May 2014 gift you with generous servings of health, opportunity, and prosperity.


The content contained in this blog represents the opinions of the authors who may or may not hold long or short positions in securities of various companies discussed in the blog based upon the authors' views. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied solely upon in making investment decisions, ever. It is intended for the entertainment of the reader, and the authors. In particular this blog is not directed for investment purposes at US Persons.
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