The U.S. stock market will perform well in 2014, but investors should not expect the same kind of return as last year, according to analysts at Wilmington Trust.
In a press briefing in New York last week, Rex Macey, the firm’s chief investment officer, predicted a total return of 8 percent this year, based on a 2015 earnings forecast for the S&P of $126. Wilmington used the current forward price-to-earnings multiple, which gave 6 percent in price appreciation plus 2 percent for dividends.
The industrial sector is especially attractive, with good companies such as Apple expected to enjoy strong growth that “investors will be willing to pay for,” Macey said.
Wilmington also likes international stocks, which are much cheaper than U.S. equities, Macey noted. The European recovery will continue and “we could see the kind of P/E expansion overseas like we saw in the U.S. last year,” he said.
But that won’t happen immediately. “Momentum and sentiment favor the U.S,” he said. “We like the U.S. today, but longer term, we expect to rotate into the developed markets,” he said.
Wilmington prefers international developed markets to emerging markets, which are undergoing structural changes, Macy said. “The story of cheap wages and off-shoring is over,” he said.
Most investment portfolios today are about 60 percent U.S. securities and 40 percent international, he said. “We expect to increase international over time, but we want to see the U.S. market run its course.”
As for bonds and the search for yield, “you would want to go with spreads,” Macey said. The Federal Reserve is accommodative and a recovery is underway, “so it’s OK to take credit risk,” he said. Investors who were worried about interest rates rising quickly—“we really aren’t”—should go to floating rate notes, he added.
Tax-exempt investors—endowments and foundations that invest in aggregate bonds—should look for more risk, Macey said. “We don’t like the aggregate bond world, the investment-grade bond world, except for high-net-worth investors. With increasing tax rates, municipal bonds make a lot of sense; that’s a safe place to hang out,” he said.
Summarizing the situation, Macey said investors should be in a normal stock-bond regime.
The Fed, meanwhile, continues to lurk in the background. Wilmington’s seven-year forecast had the theme “The Fed step back, America steps up.”
The forecast said liquidity would be gradually drained from the global financial system, as the Federal Reserve and other central banks reverse or unwind unprecedented stimulus programs.
In coming years, American manufacturing will enjoy a renaissance, driven by lower energy and labor costs relative to other countriesk, according to Wilmington. However, the labor market will remain soft as technology is increasingly deployed to increase production.
Wilmington expects the yield on the 10-year U.S. Treasury note to rise to 4.4 percent from its current 2.8 percent. The U.S. annual inflation rate will be 2.1 percent to 2.2 percent.
The American economy would grow at an annual rate of 3.2 percent, compared with 1.1 percent since the onset of the recession. In contrast, developed international economic growth will be 2.2 percent—4 percent for emerging markets, according to Wilmington.
