One Investment Bank's View of 2014

by Wayne Ferbert on December 11th, 2013

As our readers know, we are big fans of the Big Picture blog. Barry Ritholtz is an excellent market commentator and strong writer. His stuff is often picked up by the Washington Post.
 
Barry posted the Bank of America/Merrill Lynch research that predicts key Themes for 2014. You can see the post at Big Picture here which includes a link to a video to watch.
 
Barry thought the list was thought provoking while also pointing out that he didn’t agree with all of the predictions. But Barry didn’t point out the Themes for which he agreed or disagreed. But we will provide an opinion on all 10 themes below:
 
1. Be an owner, not a lender
    Fed tapering with accompanying higher interest rates, an improving US economy, and healthy earnings and sales growth all favor stocks over bonds.
My take: I agree that interest rates are heading higher so fixed income will under-perform. But I don’t think stocks will necessarily be positive.

2.     Cash is trash, but high yield is not junk
    High yield bonds and senior loans will be among the best performing sectors of the
bond market in 2014, in our view, while returns on money market funds and other
short-term assets should remain near zero until early 2016.
My take: When rates rise, bonds decrease in price. The higher the existing yield on the bond, the less price impact a rise in rates will have. So, I agree with this point – as it is straight-forward math.

3.     Pick stocks, not markets
     Falling correlations among individual equities suggest divergent returns and an
environment that favors stock selection over indexing.
My take: I think correlations will likely fall even more so this point is technically right. I just wouldn’t spend a lot of time trying to pick individual stocks as the out-performance to be had is tenuous and difficult to find.

4.     Bigger is better
     Small caps have outperformed large caps in 2013, but are now expensive and not expected to outperform
large when global growth accelerates.
My take: I agree that we will likely see a rotation from small cap as it has significantly out-performed. And if the market takes a breather in 2014, large caps will be more in favor as safer plays.

5.     Look after tax, not before tax      
For most investors, even those in lower tax brackets, yields on municipal bonds are higher than the after-tax yield on other bonds.
My take: While this might be mathematically true, I don’t like this play. The municipality matters – as default is still a real risk for some of the more poorly run states. And munis are bonds – so they will decrease in price in 2014 if rates rise.

6.     Warehouses over townhouses
      We may be in the early stages of an equity market leadership shift away from consumer-related sectors and toward industrials and global cyclicals.
My take: I don’t have a strong opinion here on these sectors – but we expect to make our rotation recommendations in January.

7.     Ride the curve
      We recommend some exposure to intermediate-term maturities, primarily through portfolio laddering,
even though we expect yields to rise.
My take: We started making this change in some client portfolios last month – so we tend to agree with this strategy.

8.     Find the next Google
      In our view, some of the best equity themes can be found among innovative companies that benefit from their investments in technology.
My take: This theme has little value as it is always true – not just in 2014. But its only relevant if you are a stock picker – which we only dabble in a little when companies are so beaten down that they must be bought.

9.     Look across the pond      
European recovery is only just beginning, in our view, and the region is poised for a longer and more sustainable rally in the equity market in 2014.
My take: We have been rotating more money in to International equity indexes all year – with a similar view of the stage of recovery that Europe is in.

10. Don’t get real
      We expect a modest decline in a broad array of commodity prices in 2014, caused by Fed tapering, higher US rates, a stronger dollar, slowing economic growth in China, and oversupply.
My take: This theme makes sense – but we avoid the commodity sector in our asset allocation strategy altogether so this isn’t really relevant to our approach.
 
It is fair to say that we agree with the BAML themes more than we disagree – but in the end, this market has not been a normal market that you can easily compare to any US market in the past. The historically low interest rates driven by the Fed make this a unique market – and in the end, the effect of the Taper will probably have more to say than anything else in 2014 on asset prices.


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