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Improving economy’s tide will reach Main Street in 2014

Updated: 2014-01-01T05:36:56Z

By MARK DAVIS

The Kansas City Star

Welcome to 2014 — the year life on Main Street stands to catch up a bit with the boom on Wall Street.

Main Street has a lot of catching up to do because stocks have been on a tear.

Major U.S. stock indexes finished 2013 at record levels. The Dow Jones industrial average gained 26.5 percent for the year, its best showing since 1995.

Some economists now are saying that America’s crippled economy, having struggled in recovery for nearly five years, is poised to perform more normally again.

“We’re coming out of rehab — finally — in the United States,” said Ethan Harris, global economist at Bank of America Merrill Lynch.

Forecasts have been buoyed by recent signs that the recovery is strengthening.

The economy expanded at an unexpectedly brisk 4.1 percent pace in the summer months, thanks to strong spending by consumers and businesses. Consumers’ moods and wallets should improve further this year thanks to cheaper gasoline, a steadier job market, better wages and friendlier lenders.

Growth continued but probably wasn’t as quick in the last few months of 2013. Official reports aren’t out yet, but the holiday shopping season was less than hoped for and businesses needed to work off inventories built up earlier.

Housing continues to grow, despite a jump in mortgage rates, with the pace of housing starts topping 1 million a year. Manufacturing, a key jobs generator, expanded faster in November than it had since the spring of 2011.

And all this comes despite Uncle Sam, who has been an economic bully with his fiscal cliff, sequestration and partial shutdown. Washington should be less of a drag on the economy this year.

Unfortunately, few forecasters see anything like an economic boom. Steady, most of them say. Better, but not great.

Jobs forecasts remain stubbornly tepid. Most estimates call for monthly jobs numbers just short of 200,000, on a par with the year just ended.

That’s because many economists — despite forecasting a stronger 2014 — say the recovery lacks the momentum to break out of its modest-to-disappointing pace since 2009.

If the economists are proved wrong (and it has happened often enough), they probably have understated the girth of economic gains ahead.

“It’s as if nobody wants to believe that things are actually getting better,” said David Rosenberg, chief economist at Gluskin Sheff.

Rosenberg believes, and his is an opinion worth noting. He was one of the first economists to see the recession in 2007 and forecasts “economic acceleration” that few others see.

The stock market, meanwhile, is likely to pause to catch its breath after 2013’s run. A drop of 10 percent or so is overdue, but money managers largely expect the market to recoup that and finish 2014 a bit higher.

Bonds may have a rougher year. Interest rates are set to climb, and that will take a bite out of bondholders’ wallets.

Just like before

Rosenberg’s economic optimism starts with the surprising boom on Wall Street. Stocks, he argues, climbed during 2013 in anticipation of a stronger economy.

Just as they did in 1983, 1993 and 2003.

His point is that the market’s prediction in each of those years was largely dismissed but dead-on. The economy beat expectations handily in 1984, 1994 and 2004, he wrote in forecasting a better-than-expected economy this year.

“So expect any surprise in 2014 to be to the upside,” Rosenberg said.

Economists generally agree that 2013’s economic growth, estimated at a sluggish 1.7 percent pace, largely was Washington’s fault.

A year ago, lawmakers had given us a New Year’s Eve fix to the fiscal cliff by raising taxes and slashing spending. They topped that with a partial government shutdown in October.

It was enough to cut the economy’s growth rate roughly by half in 2013.

With few if any Washington antics on the horizon, Rosenberg expects the economy to grow something like the 3.4 percent it would have managed last year on its own.

That’s a bit rich for Scott Anderson, chief economist at Bank of the West, though he sees the economy “firing on all cylinders in 2014” but growing only 2.8 percent.

Harris, at Bank of America, similarly sees a broader recovery with more parts of the economy contributing. But he feels ahead of the crowd by calling for 3 percent growth in the economy.

The consensus based on Bloomberg News’ survey of economists puts the economy’s growth rate at something close to 2.7 percent this year. But there are doubters who foresee 1.5 percent to 2 percent growth.

Consumers count

What’s missing in forecasts is any significant worry about a recession or likely scenarios that would cause one.

A year ago, some economists openly compared Washington’s fiscal cutbacks to the federal stinginess in 1937-38 that prolonged the Great Depression. Washington’s drag slowed the 2013 recovery but didn’t stop it.

They had worried that slowdowns in Europe and China could damage the U.S. economy. Now, BlackRock’s forecast says 2014 “will likely mark the first synchronized rise in global growth since 2010.”

Even the Federal Reserve has found the confidence to begin rolling back its all-out effort to boost the recovery, albeit ever so slightly.

The key for 2014, said Hank Herrmann, chief executive officer of Waddell & Reed Financial, is whether the economy has built enough momentum.

“We do look like we finally could be getting to a growth rate that could be self-sustaining, that it’s on its own two feet,” Herrmann said. “I think that’s critical.”

Economists are counting on consumers’ contribution to get the economy on that sustained path.

They see lower energy prices as a big boost for consumers, who will save money at the gas pump and on heating bills. Consumers, like businesses, have reduced their total debts substantially, which means interest expenses won’t pinch budgets badly.

Wages also are seeing some upward pressure. Pay is rising in jobs where qualified candidates are getting scarce. Pay also is climbing because more of the jobs the economy is creating are in higher-wage fields such as construction and manufacturing.

“People and investors in general are going to have more confidence moving money into an economy where economic activity is starting to accelerate,” said Bill Greiner, chief investment officer at Mariner Wealth Advisors.

Still, most forecasts for 2014 see job gains just short of 200,000 a month, which is where 2013 was and 2012 had been.

The hope is that the more optimistic forecasters prove correct.

Anderson, for example, predicts 2.6 million new jobs this year, which would mean about 217,000 a month. Rosenberg said he has a bet that at least one of those first-Friday-of-the-month reports from the Labor Department will show more than 300,000 new jobs. That hasn’t happened in more than three years.

None of the forecasters see 2014 solving the problems of the long-term unemployed.

More market gains

It would be asking too much for the stock market to repeat 2013’s stellar performance. Prognosticators, however, remain optimistic that 2014 will produce gains by year-end.

A steadier economy, more jobs and a narrowing federal deficit all help stocks, said Bill Koehler, president and chief executive officer of Tower Wealth Managers in Kansas City.

This year probably will close with something short of a 10 percent gain, he said, and give investors a more volatile ride.

For starters, the market’s overdue for a short-term correction that lowers prices for a while but leaves the market’s uptrend intact. Koehler said January marks 28 months since the market has seen as much as a 10 percent drop.

Several forecasts see interest rates on 10-year U.S. Treasury bonds climbing no higher than about 3.5 percent, and that the stock market could handle that rise. Higher interest rates hurt stocks partly because they give income-starved investors someplace to earn a bit without having to put money into dividend-paying stocks.

“Rates heading toward 4 percent would be a significant speed bump” for stocks, Koehler said.

It could be a trigger for that overdue correction in stock prices.

Many analysts argue that stock prices, despite the big run-up, remain reasonably priced when compared with the profits companies produce.

Herrmann, at mutual fund manager Waddell & Reed, said there is room for higher earnings this year and for higher bids from investors for those earnings without making stocks overpriced.

The Standard & Poor’s 500 stock index could climb 10 percent this year, he said, adding that history is on his side.

Seven times since the end of World War II, Herrmann said, the S&P 500 has gained as it did in 2013, and six times it still produced at least a 10 percent gain the next year. Call it momentum.

Technology stocks land on the favored lists of Herrmann, Koehler and Greiner. Think old tech names and new high-growth areas of technology, Herrmann said.

Energy stocks, notably companies that provide services in the oil patch, also look promising to Herrmann. Koehler said Tower Wealth has been adding European stocks, which have become relatively cheap.

Investors are more likely to notice what is happening to their mutual funds that own bonds — whether through a 401(k) plan at work, individual retirement accounts or other investments.

That’s because rising interest rates hurt bond prices, as well as the prices of fixed-income mutual funds that own them.

The pain is greater for owners of long-term bonds, those that mature in 10 years, for example, than for owners of short-term ones that mature in two to five years.

And this teeter-totter effect between interest rates and bond prices hits U.S. Treasury securities along with corporate bonds and other government bonds.

One solution is a tactical shift, Greiner said. Move toward bonds with shorter maturities and accept a greater risk of default. Defaults will be less likely in an improving economy, which means price drops from rising interest will have “sharper teeth” this year.

The bite of higher interest rates could turn into a wake-up call for bond investors. Few seemed to notice the effect when U.S. interest rates climbed steadily from May to September.

“If they were awake, we would have seen a much greater exodus from fixed-income funds,” Herrmann said.

To reach Mark Davis, call 816-234-4372 or send email to mdavis@kcstar.com.

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