Welcome to the Daily Briefing.
There are eight significant factors that potentially can impact the American market over the next 3 years in either a negative or positive way. If these events occur the market will react. Today’s briefing will quickly describe changes in these subjective factors and recent rating changes we have made to the probability they will occur.
Let’s first start with the negative factors so that we can end this briefing on a good note. The first negative factor deals with the continuing chance that there will be a major sovereign default by a European Union member. We all remember last years discussions on Greece, Spain , Portugal and Ireland being in a real mess and possibly defaulting. Given the actions taken by the European Central Bank, referred to as the ECB, gentle improvement in economic growth and a combination of reduced government outlays and increased taxes, the probability of a default in 2014, 2015 and 2016 have dropped by half in each year throughout the period. In 2014 there is now only a 10% chance of a default occurring, 2015 has dropped to 18% from 32% and 2016 is down to 22%.
The second negative risk factor is a N Korean confrontation spreading beyond an attack on S Korea and drawing in regional and/or global participants. There has been no change in the probability of this occurring over the time period. 2014 remains at 10% with 2015 and 2016 remaining at 15%. Even though recent problems in the Ukraine distracted investors, we believe the real economic conflict problem could be in centered in Korea.
We read daily about the theft of confidential information involving credit cards and corporate secrets. The markets have been fairly quite about the real threat coming from data system security and that is focused on infrastructure and financial markets, or what is termed a “fire sale”. Government espionage and cyber warfare is real and occurring on a lesser extent daily. Israel has a cyber center that detects thousands of daily attempts to break into infrastructure networks. The probability of a cyber attack of this magnitude occurring has not changed from previous estimates at 10% in 2014, 30% in 2015 and 40% in 2015.
The last major negative threat comes from not the size of U.S. government debt, but the world’s belief that the U.S. can continue as a major economic power with the debt burden. Confidence in the economic power of the U.S. is a driving force in being able to service and afford the sizable debt load currently in place and building. Any doubt by the world is minimal over the next 2 years as the rate of increase is dropping. This may be more difficult to achieve in 2015 and the probability that the world begins to doubt American debt is low at 5%.
On the positive side, U.S. energy exploration and energy independence is a sizable positive that increases in probability throughout the period. The force of this economic position, on a global basis increases from a 10% chance to 20% by 2015. The probability was higher previously, but has been lowered due to potentially strong exports that could result in a stronger U.S. dollar and resulting lower export opportunity outside of energy. The trade balance will improve if energy is once again exported, but that needs to be expanded. It was encouraging to see Europe discuss the potential of offsetting energy supply uncertainty coming from Russia being replaced by U.S. supplies.
U.S. production costs continue to move in a favorable direction relative to world production costs. Emerging market production costs are increasing as a natural evolution of advances at a faster rate than the U.S. which puts the other factors such as stability, capital availability and transportation in a favorable position. Even foreign steel companies are looking at the U.S. as production centers. More needs to be done in the area of relative corporate tax reform and wage negotiations for this to increase above a 20% chance.
Earnings growth continues to be favorable with only 2 of the S&P 500 enterprises not forecasting increased earnings in 2014 over 2013. Much of the market gain in 2013 was based on favorable earnings growth. Expectations were probably more than enterprises delivered. Stock prices in 2014 will need to advance to meet the expectations before further stock gains materialize. With such favorable percentages on the upside in earnings, the probability this favorably influences the market throughout the period is high in 2014 at 40%, but drops to 15% in 2015 and 10% in 2016 as it becomes increasingly difficult to produce stronger earnings.
The last favorable risk factor is U.S. economic growth. Even though politicians would like to see higher levels in all categories, it appears the growth rate is strong enough to produce good news for the market. GDP consistently above 2% has a 40% chance of occurring throughout 2014 and a 20% chance of continuing to occur in 2015. The next year, 2016 may prove difficult to continue along such a smooth growth path.
I hope you have enjoyed this Daily Briefing.
Listen in tomorrow when we will be discussing international markets and important daily events.