Outlook for markets in 2014

The market will be increasingly driven by rising interest rates

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3 MIN READ

The crisis kicked off by the credit crunch in the US is slowly but surely coming to an end but it will leave behind it the seeds of the next crisis.

The key indicator to following this process is to watch global currency prices.

Classically the way out of a recession or crash for a country is to devalue so the country can boost its economy by selling more products abroad. Devaluation means booming industry, at least for a while.

It’s a simple strategy and over the years has been frequently used.

When the financial crisis begun, currencies quickly became out of sync with each other and the prevailing economic realities.

The Yen skyrocketed, the pound was crashed, the euro became too strong and the US dollar fell. The result was the main global currencies got out of line with each other.

This imbalance is finally coming unwound. The Yen is returning to proper levels, the euro is starting to soften, the pound is strengthening and at some point they will all line up with the dollar in a way reminiscent of pre-crash levels.

When this process finally reaches its destination in about a year or two, the next economic era will well and truly be underway.

Meanwhile the market will be increasingly driven by rising interest rates.

The global economies and their markets and will be driven by how well the transition to normal interest rates is handled by the various governments of the G7. The days of zero interest rates is also drawing to a close.

The challenge is that most countries can’t or won’t want to afford to service their new ballooned national debt at old style interest rates. As such the transition will be fraught.

There will be pressure to continue the process of QE, where interest rates are kept low by the government buying back its long term debt with short term new debt, suppressing interest rates by mopping up debt at artificially high prices.

This process works up to a point but at some stage bonds must turn into cash and then state financing can only be supported by directly printing money the old fashioned way.

This will be awful for bonds prices and strong for equities.

This is one of the reasons why US, Japanese and many European equity markets look so good right now. As money exits from bonds, in fear of rising interest rates, so the money goes into equities.

If QE turns into monetisation of debt and money starts flooding into those economies via old fashioned money printing, then at least to begin with the resultant boom will be great for stocks.

This process will prove tricky and, if things get out of hand, everything goes sour not just the economy.

The US is crucial in this process as it has the greatest problem with its deficits, its debt and its budget and remains the core global economy.

The US will have to navigate a path between rising interest rates, inflation and onerous debt. With the right balance, higher interest rates will be counterbalanced by inflation and will erode public sector debt, boost nominal incomes and lubricate rebalancing.

This is the road ahead.

It could work and it will be attempted and will look like a boom and for many, feel like one.

2013 was the beginning of this process and the beginning of the post-crash era. Commodities have had their boom and bubble, bonds have had theirs too and it is now the turn of stocks in the developed world to have their years of exuberance.

As the developed world enjoys its recovery, the developing world will continue to suffer its economic mirror image, recession. They are linked.

The developing world has strong economic fundamentals and weak political ones, while the developed world has weak economic fundamentals but strong political institutions.

The interlinked dynamic of the developed and developing world is creating the economic cycles we have been seeing for at least the last 15 years and will continue to do so for a long time to come.

In 2014, its good times for the developed world and tough times for the developing economies, with stock markets trading in line with these trends and bonds under pressure.

2014 will be an important early chapter in a new economic saga.

The writer is CEO of the private investor website ADVFN.com. His latest book is ‘Letters to my Broker’.

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