2014 Predictions Part 2

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Yesterday I made some predictions for economic data, politics, and Federal Reserve monetary policy that may impact the market. Today I will focus on financial products and sectors.


2014 Predictions – the Markets

What lifts the market?

The equity market, as a whole, has been lifted significantly since the onset of the QE-3 (QE-Infinity) monetary policy. The policy, which in previous iterations had been limited in scope, was now permanent. This gave some certainty to investors, as the policy created an attractive market for equities by making bonds an unattractive investment. The yields on dividend paying stocks were far more enticing, with the prospect of growth over a 10-year period that has been paying in the 2% range. Since 2012 a parade of market experts have continued to recommend dividend paying stocks over equities for the one-two punch of yield and growth; they were right. The reason has less to do with economic growth and more to do with the Fed’s monetary policy.

The Fed, along with the government and their massive Keynesian stimulus policy, was betting that if the government propped up the economy, markets, and bonds that eventually the private sector would grow and the government could eventually pull back on spending. That has not happened and it looks to remain in effect for the foreseeable future.

Because of this longer-term monetary policy, at least through 2016, the market is no longer looking at it as a short-term stimulative effort but now believes this to be the norm. The market and investors have become, in some sense, addicted to the monetary policy, thus making it harder for the Fed to wean us off. Bernanke took the first step a few short days ago with the first taper, but with the changing of the guard to a far more Dovish and pro-QE leader, Yellen, will we see the taper and march to winding down the QE operation as steadily as we expect?


Equity Markets:

I think there is a general bubble building in the equity markets, but that doesn’t mean that all sectors will be affected. I believe in 2014 we will continue to see a divergence between the Western reliant companies and globally positioned companies. There are also some great stories in the technology sectors that I believe will have continued growth in 2014. While we may see the market move higher in its entirety, I think investors will need to be more specific in their investments, rather than just buying the S&P and expecting a solid return.

Technology:

I am generally bullish on the technology sector, but I need to be more specific because it is a big sector that encompasses many areas. I would generally say robotics, 3D printing, and SaaS are the places to be bullish. I would avoid the smart-phone space (which is turning into a commodity), social media (which has troubles figuring out how to monetize their offerings), and general hardware (which is also commoditized with very thin margins and high competition).

Technology is a given

We saw IBM, HP, DELL and others move into the SaaS model because hardware is a difficult place to make money these days. IBM and HP have been successful and Dell is getting there, but has its own problems.

We have also seen the power of Cloud Computing along with higher speed internet access bring forth on-demand content providers. Netflix, Spotify, and others have created a rapidly growing streaming media industry. New TVs all have internet as well as Netflix, Hulu, Vunu, and a host of on-demand content providers factory installed. Netflix is currently king of the hill, but there are others that are doing very well and they could be take-over targets in 2014. Google and Amazon are both moving quickly into this space, as is Microsoft. HBO Go is making huge inroads as well. The music seen is just as hot, as I type this I am listening to Spotify (on-demand music). No longer do we need to buy CDs, or download from iTunes, we can build our own online libraries of music and access it from anywhere. The battle for on-demand media is moving forward and this is a growing space for 2014.

As I posted earlier this year, Cloud Computing and Big Data has seen a spark and growth in the Software As A Service (SAAS) industry. Like on-demand media, business and productivity software is gaining ground as well. Google Docs has been out for a long time and was probably ahead of its time, but business software is moving off the hard drives of local machines and moving into the cloud. There are several private companies that could IPO in 2014 or be excellent take-over targets. Mule Soft, BOX, CYAN, SKYTAP, FireEye, Coupa, Veeva, are just a few of these fast growing business online software companies.

In 2014, will see a huge growth of moving off our local machines and move truly online to listen to music, watch movies, play games, and use business software. I guess you could say technology is going backwards as to how we interface with computers. When I first started using computers, we were already in the cloud. Universities used “dummy” terminals to access the networks, then in the mid-1980′s we saw computers brought into the home, the PC was born and we moved away from using terminals to access “main frames”. It seems like we are moving back to the “main frame” and “dummy terminal” methodology as SaaS takes hold.

What about the big names like Apple, Google, and Microsoft?

I think Apple is facing interesting times in 2014. The upside for Apple is that their China Mobile deal, with over 700 million potential clients, has some major sales potential. The problem is that smart phones are turning into a commodity and margins are getting significantly compressed. Are Chinese consumers willing to pay a huge premium for the Apple product? Apple is already working on an even cheaper version of their current product lines to penetrate the Chinese market. They are betting on branding because their iPhone is not the best and only product in the market. iPhone clones and knock-offs are in some cases even better than Apple’s product, offering SD cards, dual sim cards, and other advantages; all for half the price. The question is does Apple’s premium brand carry enough weight win the Chinese consumer over to buy a more limited product for twice the price? There are also some concerns about the Apple universe (iTunes and OS) making market penetration. If you buy an iPhone you are also buying into the Apple universe. This does not pose a problem in the states in which we grew up with Apple, but in China and other markets, the MAC OS doesn’t dominate and neither does a premium service like iTunes. Apple’s other problem is that it seems to be losing the SaaS race. Apple TV has not turned into the big hit many anticipated. Apple is not in the TV space and Samsung is dominating there and have already released more SaaS type of TV sets with built-in internet, Wi-Fi, Bluetooth, Netflix, and a host of other services. Personally, I think Apple is not a great buy in here and I think we could see Apple decline back down to $450 as investors chase the latest and greatest. Apple is in its own universe and not at a price that I am willing to buy.

Google, Amazon, and Microsoft are moving quickly into the Cloud, Big Data, and SaaS space. All of them starting to offer premium online content. Windows 8 is starting to come around to be a hybrid platform and many are starting to move on board. Dell and Lenovo released the first 8” and 10” full Window’s 8 tablets. That is a huge step forward in the tablet market and brings some serious competition to Google and Apple. These new tablets are full-fledged computers, not just running apps. I picked up a Lenovo Miix 2 (8”) and I am rather shocked how well it runs a full version of Windows 8.1, Office, and I have even downloaded SOFTWARE, not Apps. I saw a video from a small company called Plugable with the Dell 8” windows Tablet that shows how powerful this thing is. While it is still the first generation, by the end of the year we could see people replace entire desk-tops with tablets and docking stations. My partner already uses an ultra-book (MacBook Air with Windows on it) for his main computer in the office and while traveling with docking stations.

There are some great things moving forward in technology, but I also think we need to be very careful with some of the over-hyped companies. The problem with Facebook and the Twitters of the world is that their stocks have rallied on hype and branding; eventually they need to make money. Facebook has done well to turn their ship around and learned to monetize Facebook, but Twitter is light on revenue based on their current evaluation. There are a host of these companies like Groupon and others, they get the hype, they have the name, but do they have the revenue? We could see a small internet bubble in these type companies.


Financials:

Occupy  Bull-Street

2014 is going to be a hard year for financials. The JP Morgan fine (in the billions) and now the possibility of facing more charges, including criminal, was the precedent set for 2014. Goldman, Bank of America, Citigroup and others have already been named in several similar probes and investigation from the SEC, FBI, DOJ, or name your three letter government agency. The Volcker Rule, part of the expanding Dodd-Frank Act, is also a huge crush on potential revenue. I don’t think these stocks will crash, but I think they will have a difficult time seeing any solid growth or paying any substantial dividends. Occupy Wallstreet isn’t over, the battle has just moved from the street to the DOJ.


Pharm and Health:

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If a company gets an FDA blessing on a drug that could be sold to millions, it’s a cash cow. We saw in 2010-2012 the big companies gobble up the weak. Mergers and take overs were happening left and right. Companies were buying pipelines for discounts and it certainly helped. However, the big mergers and acquisitions in this space are over, it is now about producing new product lines and looking at small companies to acquire. The risks in this sector are two fold, liabilities from class-action lawsuits on existing pipelines and government over-sight / regulation / approval. Either of these two things can bring a big company to their knees in one quarter and stall growth.

I don’t even know what to make of Healthcare, mainly insurance. They have caps, more liability, and now government intervention. There is still profit in the model, but until we find out what happens with Obamacare and the continual changes, I think this sector has too many unknowns.


Commodities:

best commodities tips

The commodity market has been depressed and I would say overly so. While I am bullish in very specific target markets in equities, I believe the commodities market is where the real value is. Much of the commodity price decline is based on the QE policy and also the lack of money velocity, which has kept inflation in check for now. Also the West (UK, Europe, and US) have all been playing nice in the currency and monetary sandbox. All of them have been moving forward with their stimulative efforts, keeping a somewhat equilibrium. Japan however launched their first salvo in the currency war with their ultra-aggressive policy, which saw a huge move in the dollar/yen. That expanded further when Bernanke tapered and Japan ramped up their printing. The currency war will bring volatility to commodity prices, which have remained under pressure and in a low volatility environment.

While I am bullish on Gold, Silver, Corn, and general hard/soft commodities at these levels heading into 2014. I am neutral on oil. The oil market is a different animal, now with three major oil prices (Sweet, WTI, and Brent) all dealing with their own supply/demand issues (from refining, transportation, storage, and use). They will remain in flux and most likely hover in 90-110 range through 2014.

Many of you may know my gold and silver philosophy, which is more of an alternative form of savings, rather than an investment or hedge. I am currently working on a lengthy paper on gold and money, which I should have completed sometime in 2014.

I am bullish on commodities in general and we will most likely see something happen in the 2nd quarter.


Currency:

There is no way that I would store dollars, yen, pounds, or euros for any store value. Sure, we must trade and transact in those currencies, but I don’t think they are worth holding against tangible assets. Property, gold, silver, and stocks are far better places than Western currencies, in the long haul. All these nations have trillions of debt, create trillions more per year and their central banks are artificially keeping interest rates low because their collective governments can’t afford higher interest.

I think we will see more sovereign debt problems in Europe and also here in the States. Detroit is not the only city with problems, Chicago and others have huge amounts of debt. I am sure the Federal government will come to the rescue, but that is just shifting local debt to federal debt and in the end what does that mean for the creditability of the currency?

Australia is one of the few commodity currencies and while it has slowed and come off in the exchange rate, I think it is a far safer place then the Western debt nations.

Swiss Franc is also remained isolated, for the most part, their government has manipulated it to the euro somewhat, but when push comes to shove it is a far more stable currency with lowest debt among the West.

Hong Kong and Singapore dollar are better alternatives as well, for any lengthy store holding. The Hong Kong dollar is tied to the US, but if that ever came off you would see a 20% drop in the US dollar exchange rate. These are stronger currencies and their lack of price fluctuation is only because of an artificial peg.


Bonds:

us-treasury-bonds

I would avoid US treasury bonds, they pay nothing and have a higher chance of going down in a free market and taper environment than going up. While the long-end of the yield curve is driven more on real supply and demand, the Federal Reserve can step-in at any time. Remember Operation Twist? So, I think they will not let rates get too far out of hand. Perhaps 4% on the 10 year is a possibility, but they would do anything and everything to keep it from rallying too far.

Corporate bonds on solid companies with revenue continue to be the best place for fixed income. There are some great companies paying in the 4-5% range and I would rather take some risk on some BB grades at 8% than buying the 10-year treasury.

We will see rates go up, but the Fed will step in with some type of policy to keep it from going up too fast. The government can’t afford it and a steep yield curve hurts economic growth and consumers. It also creates trepidation with savers in fixed income, if they see yields moving up too fast. Their question will be when is the best time, as yields go up and bonds fall.


Inflationary Concerns:

inflation

While I am bullish and bearish in certain sectors, my overall opinion of the equity market is that we may see some high movement, in general, in the first quarter. However, my concern is about the inflation that has not come to the surface in the last couple of years. If you study history, this is very reminiscent of the London Gold Pool scheme from 1960 – 1967. The US was very good at keeping inflation at bay, but they did it artificially by selling tons of gold into the London market to keep gold prices from rising. They were fighting supply and demand, and in the end the US would lose. Inflation came on fast and hard, no one seemed to expect it and it took Volcker, with a very aggressive interest rate above 20%, to bring inflation in check. Rather than selling gold to keep inflation from happening, the Fed is printing money and flooding the system with the QE monetary policy. It has kept everything in check for now, or so it seems, but they can’t do that forever. In the London Gold Pool scheme one only needed to monitor liquidity and volume to see the stress and breaking points. In the current QE world we need to monitor the velocity of money, which has remained in check, thus keeping inflation at bay. However, eventually the dam breaks and that’s when the velocity takes off. If we see this happen, which could happen by the 2nd quarter based on the Fed policy and/or BRIC’s position on the US reserve currency, we could start seeing some volatility enter the market. I suspect we could be in for a 10% or more correction in the equity markets if this goes unchecked.

I believe that 2014 will be the year in which we see the velocity of money speeds up and we will also see some real concerns about inflation rise. Of course, we will not see it in the CPI or the C-CPI-U, which really don’t measure inflation, but rather the “adjusted” cost of living. While certainly an important tool to measure the cost of living, it also masks real inflation.
It all comes down to the Fed. Just like the booming rally on the back of trillions of printed money which lifted all boats, it will be the Fed’s position that will set the tone.

The part of the equation we need to pay attention to is the Velocity.

Money supply * Velocity of money = Price level * Output

We know we have a massive money supply, it’s just not moving.

Khan Academy explains Velocity

In a normal market, velocity of money is close to zero and it is money supply that is raised to meet the price and output level.


Courtesy of FRED

Think about this for a second, if you let all the money flood into the system and the velocity now increases, what happens to the price level? It’s fairly simple math, we start seeing inflation.

It is this single factor that I think will have the greatest impact on equity prices to the down side and also a move higher in commodity prices.

It is important to note that I don’t believe a correction in ALL equity prices means that they are correctly valued. When the correction does come, this is a time of opportunity to buy those companies that have been thrown-out with the bath water.


General Market Predictions:

The indices are starting to get parabolic, but we have more room to go. Mostly in the first quarter. These are very broad and general estimates. I am bullish on the emerging markets and some tech areas. I am bullish on commodities. However, I am bearish on financials and the Western reliant companies. I believe the new Fed Chair will bring forth some volatility and uncertainty. I also think that if velocity speeds up we could see inflation and that could drive down equity prices and rally commodities. I think we also need to focus on the emerging markets and Africa. We need to keep an eye on growth and avoid nations trying to inflate their way to prosperity on the back of more debt.

INDU: 15,000 – 17,000
We could see 17,000 in the early part of the year, perhaps the first quarter, then a correction by summer and pull back to the 15,500 level. We’ll end the year flat after some volatility.

NDX 3200 – 3700
I think that 3700 is in the cards early this year. Then a pull back down to 3200 area. Some of the SaaS businesses will do well, but get trapped in the volatility of the general market. Apple will no  longer be the darling of the market it once was and while their China Mobile deal might be a great avenue, I think the company will continue to face stiff competition. Tim Cook is looking to create a CHEAPER competition model which will slowly erode Apple’s premium brand. Google will pull back below 1,000 again but the company remains strong in the long-term. Could this be the year of Microsoft, with a new CEO and new product lines?

SPX 1600 – 2000
I think we could see a move higher and if the “shoe shine boy” jumps in, then why not 2000? If we get that rally in the first quarter, I suspect we see the VIX drop into the single digits and that will be a huge warnings sign. I suspect we could see the SPX fall back 1600 when the correction comes.

RUT 900 – 1200
The broad-based index will certainly get to 1200 and perhaps even 1300 by the first quarter. We need to see this parabolic rally ramp a little further before we get a good stall. I continue to watch the RUT for general market order flow and I think it will be the tell-tale sign in 2014. It will most likely weaken first before any correction in the narrower markets. I suspect that a pull back to 1000 or even 900 is in the cards on a correction. We will finish the year flat most likely, after a bounce. That all depends on how early we get a correction in the year.

Gold 1000 – 1500
We could get down to 1000 in the first part of the year; however, I am already seeing demand at these levels. So I wouldn’t wait on that. I think we could finish the year at 1500+, which all depends on the Fed, taper, and the velocity of money which could bring forth inflation. The currency war will continue to hit up which will eventually seem more moving into physical gold.

Silver 17 – 30
We may flirt with these low levels, but I see Silver on a run up to 30 this year, along with Gold for the same reasons I mentioned above.


Conclusion

If we measure the markets over the year, I think it will be mixed to flat. A good rally in the beginning, a correction, and then a leveling off and reassessment period. The emerging markets will continue to outpace the West. The big risk factor is not going to be business, earnings, or fundamentals, it will be the US dollar and monetary policies.

I am not saying to go out and short the markets tomorrow, we could see a good follow through rally into the New Year. I am saying be prepared for a solid correction.

I would watch the VIX and the RUT index as my early warnings signs. Could 2014 be the year of the “shoes shine boy”. We are starting to see a general bullish mood in the market and we are starting to reach parabolic rises, but we have not seen the “shoe shine boy” yet. I haven’t seen him at least. I think we could in early 2014 and that will also be a warning sign.

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