The New Year is just a short week away and I am putting together my predictions for 2014. There is a lot to cover, so I expect it will be a two-part report next week – the last two days of the year. So, before we get to predictions, let’s review 2013.
This year saw huge political volatility, but significantly less market volatility. The market, investors, and general citizens have become numb to the political circus in Washington D.C. The market rallied despite the political shenanigans, what many referred to as climbing the wall of worry.
Courtesy of izquotes.com
It looked like a tumultuous year for politics and many investors questioned how it impacted the markets. We started off the year with a huge can kick after facing the “Fiscal Cliff” and also the Payroll Tax Hike. Then we had the “Sequester” battle, where the President got on the fear train to hopefully persuade the people to put pressure on their Congressional representatives to stop the sequester. He touted that airports would see huge delays and be shutdown, the nation’s safety would be a huge concern, terrorist attacks would probability increase, and we would not be able to support our service men overseas. The people pretty much ignored it and the “Sequester” came and went with little notice. For the most part, after the first quarter, the political battles were kicked down the road to the end of the year and the big budget and debt ceiling battles. The battles at the end of the year saw a stalemate and the government shutdown, loaded with all the Chicken-Little theatrics from the media as if it was again the end of the world. Government furloughed workers came back to work and many of them doubled dipped – getting their back-pay while collecting unemployment. The Republicans were blamed for the shutdown and their popularity fell off a cliff, looking like a sure bet for Democrats to take seats in the 2014 election.
Then, of course, Obamacare turned into a full blown failure, the website failed, people would not sign-up, many suffered sticker shock at the prices, then 100′s of thousands were booted from their current plans that would not meet Obama’s standards. The administration back-peddled, delayed one thing after another and started to figure out how to fix the Obamacare mess, which will continue well into 2014 and beyond. Weeks turned into months and, of course, the political wind blew and the once hailed and popular Democrats and President became unpopular. The shift back to the Republicans happened overnight and it looked like the Republicans may take seats in 2014.
The year in politics closed on a high-note. The one thing missing among politicians of both parties was the willingness to work together. Two people decided to sit down and ignore their ideological differences and at least try to get something done. Paul Ryan (R) and Patty Murray (D) sat down and hammered out a 2-year budget deal. It wasn’t great or anything particularly special, did little to improve fiscal issues or the budget, but it did show that two people from two different parties and beliefs CAN get something done. After a year of political stupidity, ignorance, arrogance, and kindergarten antics we finally see that at least two people can rise above and come to a compromise. Perhaps that is a good sign for next year, we can only hope.
Courtesy of CNN.COM
2013 was certainly a soap opera style year at the Federal Reserve. Rumors swirled that the Democrats and the President were not happy with Bernanke. This started back in 2012 as Bernanke became more vocal and critical of government deficit spending, lack of a budget, and ballooning debt. In one famous Senate testimony exchange, Senator Chuck Schumer (D) told Bernanke that he must continue to print money and do something because Congress couldn’t get anything done. Bernanke warned that QE was not going to continue forever. The fight between the Federal Reserve and government was a silent battle, the government needed money, and the Fed was the only source. In one of the most controversial decisions at the Federal Reserve, they launched QE 3 – which, unlike the previous iterations, was indefinite in time and scope. It started at $85 billion a month with the ability to raise or lower it, with a target of over $1 trillion per year to finance government deficit spending as well as to continue to buy up the unwanted MBS securities. Bernanke had created an addiction and he didn’t like how strongly the Federal government became reliant on it.
Bernanke’s term is over in 2014 and it was unknown if he would continue, but that quickly changed when the President, in an interview, pretty much said he wasn’t coming back. When the President was pressed about Bernanke’s options, there was no option – he wasn’t going to be the Fed chairman going forward.
The only reasonable and logical candidate was Janet Yellen. She is a woman, which makes for great political theater and scores good political points and would be the first women. She had been the SF Fed President and was now serving as Co-Chair of the Federal Reserve. Lastly, she was a staunch Keynesian who was also supportive of both QE and fiscally stimulative efforts to jump start the economy. Most likely she would keep the Fed in line with the political will of the President and the Democrats. The board of governors, appointed by the President, was stacked with Keynesians and supportive of the his fiscal and social policies. Now it was all about removing Bernanke.
Bernanke tossed a monkey wrench into the gears by announcing a possible reduction of asset purchases (part of their QE program), which quickly became known as the Taper. This was the first real event that stalled the equity rally and brought fear to the market. Bernanke had several things going for him. The Sequester and Payroll Tax Hike helped reduce government deficit spending, not to mention the billions in mark-to-market accounting gains from the GSEs that would go back to the Treasury. This meant that while the Fed would still be the majority buyer of Treasuries, the government would issue slightly less Treasuries as the deficit was reduced. This also put the kibosh on the Keynesian stimulative support for the QE program. Remember, the Fed governors as well as Yellen were openly supportive of the QE program and had stated that they would reduce or perhaps even raise asset purchases as the economy required. However, it was the President and the Democrats that wanted to increase stimulative efforts and raise more money, which the Fed governors supported – with Bernanke warning of a taper that changed the dynamics at the Fed. In the months that followed we saw the division between the few Hawks and many Doves launch into rather polite jabs at one another about the Taper. Fisher and Locker were the most critical of the bunch, openly not supporting QE3 and also calling for a TAPER and even an end to the program. Fisher hoped that it would force the government to become more fiscally responsible and to not rely on the Fed to continue to fund deficit spending. Yellen and her doves said they would consider a Taper only if the economy warranted it, but was also quick to add that they might need to raise it. It was as close to blows that we would ever see in the Hawks and Doves battle, much more polite than Democrats and Republicans.
Then the Federal Reserve story turned into a full blown soap opera as Larry Summers entered the mixed. Summers had been a close advisor to the President and was promised the Federal Reserve Chairman role back in 2010, when Bernanke’s term was to end. When The President failed to keep his promise and appointed Bernanke to another term, Summers left the White House in a huff. He openly criticized Bernanke and the QE policies, perhaps hoping it would fail. Summer’s had become famous for talking off the cuff, pissing people off, with his vocal and vindictive nature. When the Chairmanship opened up again, it was “people close to Summers” that injected stories into the press that Summers was the President’s favorite and had been promised the position once before. Whether the President truly considered him or if this was just Summers trying to shoehorn his way back into the job, we may never know, but it did add a huge amount of drama to the equation. I never saw Summers as being a real possibility as he is too volatile, would certainly not kowtow to the President, and would have a difficult time getting through any confirmation hearing. Yellen was the real choice and the only choice for the President’s economic agenda.
Each subsequent Fed meeting or speech turned into a bet as to whether they would taper or not and if the President would announce Yellen or Summers. The market sold off into high expectations of a Taper in the 3rd quarter, and when the Taper didn’t come the market rallied. Then it was official, Yellen was nominated and the Summers faded into the sunset.
The stars were aligning for the President and his economically aligned Federal Reserve, Yellen would get appointed – people didn’t want to vote against the first women or someone as well-known and respected as Yellen.
There was just one meeting left, Bernanke was still in charge and there were many questions as to whether he would taper. The prediction became 50/50. Mathematically there was room to taper; estimates based on current government deficit spending were between $5 – $15 trillion. Bernanke also wanted to end what he started. It also put Yellen in a very tough spot and it would also set a precedent and expectation that the Fed would have to continue to the Taper. Bernanke could no longer be blamed if the Fed stopped tapering or even increased their QE policy; he would be on record of starting the taper.
Courtesy of grassrootjournal.com
The economy did fairly well, but not nearly as well as government data reported. We saw massive changes in how the government calculates data. At the beginning of the year the government considered switching measuring inflation with the current CPI model to the C-CPI-U model, which under-reported inflation by an additional 50 basis points. Politicians even openly discussed moving to the C-CPI-U model to help reduce the deficit spending and create a back-door method in reducing Social Security payment. I found it shocking that the media and population, in general, didn’t find this more appalling that they considered the changing the CPI model for really nothing more than a deficit reduction tool.
The Commerce and Labor Department also announced changes to the “seasonal adjustments”, but never bothered to tell us what those adjustments are and why they are making them. This affected several data factors.
The biggest change came to the GDP model, which now included non-tangible assets. Economists pointed out that it would balloon the equity of this nation by trillions and that the government would have to go back and revise all of the GDP history to account for it. A few very detailed reports predicted that it would increase the GDP by more than a full percentage point.
Meanwhile, the U3 unemployment rate continued to fall as the participation rate continued to fall and now at a 35 year low. There were several anomalies in the data; Labor Department computer error, California failing to report, several states under-reporting, etc. By the end of the year the Labor Department stated that they finally got everything under control, but they added they were not sure how the “seasonal adjustments” may impact the data.
Economic wonks shook their heads all year over the huge changes in the models, the computer errors, and under and over reporting. However, beyond the changes and machinations in the methods and models, what continued to be a bigger problem for the economists was ascertaining how much the private sector was improving vs. the government stimulative efforts and Federal Reserve’s QE program. Remove the QE program and other government stimulative efforts and what would the economy really look like? No one could truly answer that question and now, with all the huge changes to the models, it would be harder to derive real private sector economic growth.
The good news was that, even with all the economic data problems, the economy did improve and even the core GDP (at 1.7%) was showing a slow plod higher.
Revenue and Sales:
2013 was a year of lackluster earnings. In fact, every quarter (so far) saw weaker earnings and weaker domestic top-line sales and revenue. What continued to be the driving force was the growth in the international markets and emerging markets. Top line revenues contracted for the first time since 2010 in the Western markets and we also saw margins compress as businesses tried to drive sales.
It was a mixed year, the luxury brands continued to see growth and the emerging markets saw growth. The bulk and domestic retailers are the ones that struggled the most. Heading into the holiday season we saw warnings from Target, Walmart, Sears, and others. We also saw initial retail sales numbers contract by over 2.5% on Black Friday weekend. This initially boosted concerns; however, online sales came to save the day. There was a massive increase in online sales, so much so that FedEx and UPS were swamped and, between weather and a flood of orders, had problems making delivery. Perhaps 2013 marked the shift where online sales now become the bell-weather.
While it was a great year for equities it was a bad year for commodities. We saw an order flow shift from every other investment pool and into equities on a massive scale after the launch of QE. It was the only place to be, regardless of fundamentals or political volatility. The Federal Reserve was keeping the target rate at zero, buying bonds and forcing a move into equities.
Oil remained flat for the most part, but we saw some very interesting issues in the oil market. The US focuses on the West Texas Intermediate (WTI) while the rest of the world uses the Brent Crude price. They are normally priced similarly, but the spread started to expand in 2011 as we saw new oil come online in North Dakota. The US saw more oil and that kept WTI prices lower as Brent Crude stayed above $100. The spread expanded to almost $30 and some thought the US was about to become oil independent and the spread could widen further. However, there was a huge logistic problem in the US. With no pipeline, the oil was getting bottle-necked and not making it to the refineries over 500 miles to the south. Once they cleared the bottle neck, we saw a glut of the Light Sweet Crude hit the Gulf refineries. The US saw stock piles of oil rise, but we could not refine fast enough. There was additional problems as most of the refineries were designed to refine the heavier OPEC type oil. The US is blocked from selling oil abroad, except to Canada, and now we have a glut of Light Sweet and we are starting to see a crack in the spread between Light Sweet and West Texas, as well as Brent Crude. The US is facing a logistics problem of moving the oil, not being able to sell the oil overseas, and also not being able to run full refining capacity on the Light Sweet. Can there be a problem of too much oil? It seems so.
Gold saw the biggest drop in price in decades. However, what was very interesting was the huge supply in paper gold (Futures and ETFs) and the lack of physical gold deliveries. Several countries tried to schedule huge physical deliveries, but the US was unable to comply. The story about Kyle Bass being forced to wait on his physical deliveries from his future contracts also drove some concern. What seem to be happening was that we saw shorts in the paper market. We saw the biggest rise in GLD ETF short-interest since its inception. We also saw several massive orders in the gold futures market. One order was bigger than the current fractional reserve amount. That seems impossible, but with futures there is no standing float and the reserve pools are fractional, as we learned from Kyle Bass’ story. On one occasion, I was unable to take delivery for one of our funds – the dealer (from the mint) just didn’t have enough on hand and demand outstripped supply. Gold prices were dropping in the paper market, but the physical was harder to get in any quantity. While these incidents were short-term and few, it did show how fast the liquidity in the physical market could dry up.
If I look back on 2013 as a whole, it seems it was more of a year about political stories and there was little if any coverage about actual fundamentals. The “Sequester”, government shutdown, Obamacare, Summers vs. Yellen, and the Taper fear ruled the headlines. The equity market ignored it all and even ignored much of the actual fundamentals. Government economic headline data was improving, regardless of the math or models and that is all that seemed to matter.
Was it a good year? It was for equities. For commodities, bonds, cash, jobs, the economy it wasn’t all that great.
Support & Resistance
The Santa rally is still in effect. We should have a quite low liquidity and low volatility day ahead and I don’t expect too much action next week either.
The tech heavy index still has some great stories and growth in the emerging markets. It continues to climb and is starting to look parabolic on a monthly basis.
Are we getting parabolic? The VIX is falling and is in the low 12′s, it could get down into the 11′s or even 10′s. We could see a follow-through rally at the beginning of the year, but I would watch the VIX closely to see if it gets too low.
RUT 1140+ The RUT continues to be the best gauge for general market order flow. It stalled a few times, but managed to turn around and move higher, but doesn’t have the same fortitude as the narrower based indices.
Next week will be the two-part 2014 predictions. So write them down and I am humble enough to take the criticism if , and of course when, I am wrong. It should be fun and hopefully I will be able to give you some food for thought. Never rely on any one person’s predictions, but you should listen to them well and not dismiss them out of hand. I find it more important to ask WHY someone predicts something, than to question the actual prediction itself. Hopefully I do a good job of explaining my predictions, regardless whether you agree, such that you are able to at least see WHY I came to my conclusions and hopefully bring attention to the good, the bad, and the ugly.