Over the course of more than three decades in finance, I got into the habit each January of developing investment themes for the coming year. Some habits are hard to break, and even though investment strategy is no longer my day job, my mind has turned to the same task. Usually I come to a pretty strong view, one way or the other, about the year ahead. This year, things don’t look so clear.
To begin with, there’s an odd little thing called the five-day rule -- an unlikely guide, you’ll think, but one I came to value as an aid to confidence. The rule simply states that when the main U.S. stock-market indexes show a combined positive return after the first five days of trading, the year as a whole is very likely to be a good one; if the return after the first five days is negative, it’s a coin-toss whether the market will be up or down for the year.
Usually, stocks rise in the first five days -- as you’d expect, because over the long term they return about 8 percent to 9 percent a year. This year they didn’t rise, despite the consensus among market analysts that 2014 is going to be a good year.
Jose Ursua, a former colleague of mine at Goldman Sachs, has run these numbers all the way back to 1928. He finds that when stocks rallied during the first five days, there was a 75.4 percent chance of a rally for the year. For the period since 1950, the probability rises to 82.9 percent. Few rules in finance are as unambiguous as that. So when the first five days has been net positive for the Standard and Poor’s -- and I’m feeling bullish in any case -- I’m especially confident.
This year I’m still feeling pretty bullish, but the five-day rule is against me. U.S. stocks fell 0.5 percent -- nothing drastic, but down nonetheless. Over the whole period since 1928, a negative start implies a 47.8 percent chance of a negative year; since 1950, the figure’s about the same, 46.4 percent. In both cases, call it 50-50.
As I say, I’m in the bullish camp for the world economy in 2014. I’m expecting gains in the so-called developed economies and in a number of so-called emerging economies -- including some of my old friends the BRICs (Brazil, Russia, India, China) and some of my newer ones in the MINTs (Mexico, Indonesia, Nigeria and Turkey). I think there’s a decent chance that world gross domestic product growth will exceed 4 percent this year. And that would be good news for financial markets -- right?
Not necessarily. Stronger growth in the U.S. and other developed countries would be bad news for bond markets. In the future, they can’t depend on the Federal Reserve to press down so hard on interest rates with quantitative easing. Expect more “taper tantrums” in 2014. This could be quite a challenge not just for bond markets but also for financial markets more generally. I say this even though I think Janet Yellen’s Fed will go out of its way to pursue “dovish tapering,” in the hope of avoiding a 1994-type bond-market rout.
Here’s another complication. The U.S. trade deficit just dropped to its lowest since 2009, consistent with a current-account deficit of about 2 percent of GDP. This news was too little noticed: It shows that the post-crisis U.S. will be a different and better-balanced economy, refuting the idea that the U.S. would inevitably face a widening external deficit when it started to grow again.
But there’s a downside. A narrower external deficit could imply a diminished supply of global saving, and upward pressure on inflation-adjusted interest rates. You could see this, and even welcome it, as a necessary transition to more normal conditions -- but it adds to my concern about investments that might not get along with normalcy.
On top of all this, investors start 2014 with a perennial concern about the major currencies. Most seem to think the dollar is the least exposed -- for the reasons just mentioned -- and I go along with that. But I’m not as confident in this view as I’d like to be, partly because U.S. policy makers won’t want the dollar to rise too much.
A lot will depend on whether other economic leaders can step forward to support global activity as the U.S. strengthens. China, Germany, India and others are possible candidates. I’m convinced that a new and healthier Chinese economy is emerging. If others join in that assessment, the mood of global investors will lift appreciably. But will Germany act decisively on fears of euro-area deflation? Will India elect a government that can make effective decisions and turn that country’s vast potential into reality?
In all three cases, improvements in the credibility of economic policy could deliver excellent results both at home and in global terms. Those improvements are certainly achievable. I’d like to say I’m sure they will happen -- but hopeful is the best I can do. Happy New Year.
(Jim O’Neill, former chairman of Goldman Sachs Asset Management, is a Bloomberg View columnist.)
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