Last December, in my year-ahead outlook for 2014, I expected higher interest rates, a moderately higher stock market and a slow economy in the first half of the year.
I also thought the stock market and the economy would strengthen in the second half of this year and interest rates would stay high. As of July 1, the market is moderately higher, interest rates are unchanged and the economy has been surprisingly weak.
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Looking forward to the second half, in my opinion stock prices may increase moderately while interest rates and the economy could firm up. While the stock market remains dependent on earnings reports and management predictions about the future, the U.S. Federal Reserve and consumer spending will determine the outlook for interest rates and economic growth.
In July, companies will begin to report their second-quarter results and this will be noteworthy for two reasons. First, they will measure corporate strength without the effects of a severe winter that disrupted the economy. Investors will get a better read on how companies are faring during a continuing period of subdued consumer spending. Secondly, they will contain management predictions of corporate performance in the second half.
After the surprising downward revisions to first quarter GDP, most analysts have already cut predictions about economic growth in the second half. Upbeat management predictions for the second half would relieve a major source of worry about earnings and provide support for higher stock prices later in the year.
Most of the predictions about the economy in the second half have been ratcheted down after the slow first quarter. However, this backward looking methodology ignores what is happening in real time.
Over the last several months many economic indicators have been exceeding expectations. This is reflected in the strong performance of the Citi Economic Surprise Index in recent weeks, which points to the underlying strength in the economy.
Dwelling too much on first quarter weakness is unwarranted. At the same time, I am not in the camp expecting four percent growth for the balance of the year. In my opinion, higher oil prices, subdued consumer spending and uncertainty about the elections may hold back economic growth.
Add to that the potential for higher interest rates and unexpected inflation and I believe that 2% to 3% economic growth is more likely. While that is adequate, it would leave the U.S. economy with yet another year of below- normal economic growth.
While many commentators continue to expect stock prices to contract in a slow growth economy, I do not adhere to that belief. Stock prices are dependent on earnings and expected earnings growth in my opinion. While a slow economy hampers earnings growth, it does not necessarily prevent it.
The US economy has been in a slow growth mode for the last five years. Yet corporations have produced consistent earnings growth and currently hold record amounts of cash.
With all that cash the potential for higher dividend payouts, corporate stock buybacks and corporate mergers remains high. So while the possibility of another mild correction remains, I believe the market will be somewhat higher by year-end.
DISCLAIMER: The information in this material is not intended to be personalized financial advice and should not be solely relied on for making financial decisions. Past performance is no guarantee of future results.
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