Mid-Year Report 2014 Future: Where we may be going
Welcome back. In this third and final video, we’ll consider the future of the economy. Let’s talk about the most important things to keep an eye on for the remainder of this year. The list includes inflation, what central bankers do, geopolitical tensions and the use of corporate cash. Inflation debates will likely dominate the rest of 2014 as the measure is a key determinant of where the financial markets will move next. If the economy begins to advance at a sustainably fast pace, defined as 3% or above, then inflation will likely also follow suit. Resulting in bond prices moving significantly lower and asset prices moving out of that space. However if these predictions are incorrect as the Fed believes they will be at least for the rest of the year, then stocks could potentially disappoint and bonds could once again shine bright.
The most recent GDP report showed up one measure of inflation rose 2% in the second quarter, matching the Fed’s inflation target. We’ll see if the economy can maintain this pace in both growth and inflation rates. Everyday people believe inflation is much higher than market experts because the prices for everyday items have gone up, while the prices of other discretionary items have declined. This average is out to not much inflation but disproportionately attacks the lower and middle class, because the essential items such as food, child care, healthcare and college represents a much larger percentage of their disposable income.
In a historic move, the European central bank actually implemented negative deposit rates for financial institutions this year. Leaders of the Euro zone are so concerned about deflation and the lack of economic growth that they’re actually raising their incentives for banks to increase lending for assets and move into more risky areas in the financial markets. Some suggest this represents the central bank’s continuous aid to help sprout economic growth while others are frightened by the amount of intervention in the capital markets. Whatever your opinion, the market so far continued to react positively both in bonds and stocks each time the central bank make such announcements.
After a disappointing first quarter, US GDP bounce back to 4% growth in the second quarter, brightening near forecast for the full year. So what should we fear the most? Should we be afraid of central bank money printing and its potential to spark massive inflation? Or should we be more afraid of an economy unprepared to resume growing at a normal pace despite recent improvements. And with interest rates already at or near zero around the world, what ammunition do we have left to combat this lack of growth? In many ways, we’re entering unknown territory. It’s become clear that even the central bankers are unsure as to how their massive quantitative easing programs will truly affect the markets in the long term, as they’ve never implemented such policies to these extent. For now, massive inflation certainly remains a risk but a true recovery in the economy could help to restore balance down the road.
Turmoil has hit many areas of the globe so far this year including the ongoing conflicts in Iraq, Syria, Israel and Ukraine. Meanwhile, financial markets have remained steadfast as investors remain hyper focused on rising corporate earning and economic recovery rather than geopolitical fears. However, week to week volatility associated with these crisis has crept back into the market. Any major changes overseas could grab investor attention and shift sentiment to the downside especially amid a simultaneous Fed policy change. Still, these conflicts have not yet had any major macro economic repercussions as economic stabilization in the US, China and Japan continue to outweigh potential risk.
We knew it was a matter of time before companies began to deploy the record amount of cash on corporate balance sheets. So far in 2014, we’re finally seeing it happen. In particular, we’re seeing an uptake in mergers and acquisitions. Companies have already completed more than 780 billion worth of deals this year, dwarfing the previous six years and already nearing the entire 2007 total of 880 billion. Such deals have provided major supports for stock prices so far this year and could continue to do so into the future. The companies themselves represent some of the largest purchasers of stock so far this year. In the first quarter of 2014 alone, companies in the S&P 500 purchased 160 billion worth of their own shares. The last 12 months including the second quarter, is projected to be the greatest 12 months of share buybacks ever.
While corporate cash piles did finally decline from all the spending in the first part of the year, the piles remained stacked high. This amount of dry powder could continue to provide a source of fuel for markets as companies continue to invest in companies, new projects, initiate dividends, buy back shares and maybe even raise wages for their employees. Despite these major ongoing concerns, financial markets continue to hum along and some positive factors going forward could bolster a more sustainable economic recovery including stronger job growth and drastic improvements in consumer confidence. The 4% second quarter GDP growth bodes well for improvement in the rest of the year, and some economists believe the economy will exceed that rate heading into next year.
We will continue to study the markets daily. As always if you have any questions or would like to discuss these issues, please do not hesitate to contact us. Just a reminder, these are our opinions and make sure you talk to your financial advisor before you implement anything based on what we’ve discussed here today. For the benefit of our existing clients, please remember we only accept a limited number of new clients each year. We want to make sure it’s an ideal fit and that we can add value to their current planning, because we really are looking for clients for the long term. Who do you know that would benefit from a proactive team that is transparent and sits on the same side of the table as their client. We put your interests ahead of ours. Thank you for joining us and as always, please do not hesitate to contact us with any questions you may have.