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Market Letter

December 10, 2013

Here at the end of 2013 the Market here in the U.S. seems to be walking a high wire tight rope fueled by Central Bank liquidity and hopes for America’s better days ahead. A review of human history shows seasons and global business cycles of productivity, expansion, retraction, bubbles, crashes and periods of quiet stability. I have found that investing and trading in markets is more of an art with a little science. Long term out performance of peers is most consistently made by those who seem to know where the market of valuing is heading.

As a Nation business productivity has seen technological changes from the mid 1960s to launching of Twitter, 53 years of growth and change. Now a farmer can handle between 1500 and 2000 acres by himself versus 200 acres for his father. This productivity is good for the bottom line yet the irreversible effect of technology on jobs is beginning to be apparent to many economists and market analysts. Let alone Central Banks. The question now shifts, how long can productivity continue to rise? I for one believe that information technology will shrink the labor pool of qualified applicants over time in developed nations. Emerging countries and their markets will see growth in cyclical sectors. In the West an aging population has already shifted and allocated human and financial capital toward treating symptoms and prolonging end of life care rather than ensuring a life of wholeness and peace. Our National economy will see a rise in personalized medicine and self diagnosis through mobile and cloud based technology.

Market analysts in the U.S. continue to wonder where the Central Bank is taking us. When will liquidity be withdrawn? What will happen when the punch bowl is taken away from the party? In June of 2013 3 Trillion in global equity market value was erased in 5 days after the threat of “taper” was announced. Here at the end of the year the Market seemingly has priced in a taper of some degree. Or has it?

Since the economic crash in 2008 fiscal policy in global markets has been driven by Central Bank planners. They have put the tracks back together and the train has steadily chugged up a steep hill saying “I think I can, I think I can.” I believe the Federal Reserve here in the U.S. has noticed that the reality is the jobs are not coming back to the level we are accustomed to seeing in past recoveries. By pumping liquidity into the system the Fed has created imbalances in asset classes. These Central Bank planners see the potential of a more deflationary scenario. The collapse of asset prices on a global scale. It seems that aggregate demand may not be there for the long haul. If the Fed in the U.S. pulls back on its liquidity emerging markets as well as many asset classes will drop in value. Interest rates will rise at least toward the beginning and cost of capital will increase. Perhaps this is why many corporations are hoarding cash on their balance sheets. So where are the risks and rewards in the upcoming year 2014?

Global markets

Three years ago I projected 2014 to be the year of diplomacy on a global scale. Nations rise and nations fall. Alliances will shift especially in the Middle East and perhaps Asia. One area to watch is the Caucasus region. Russia and areas south still have potential of wide scale disruption and conflict. An emerging alliance of Israel, Saudi Arabia, Jordan and perhaps Egypt will begin to take shape with or without the U.S. involvement. Watch a strengthening between Iran and former Soviet controlled lands along its Northern rim.

Europe may come under some pressure once again as the countries continue to see an aging population and labor still not seeing transformational changes that are necessary for long term growth. The euro should continue to hold up relative to other currencies unless the U.S. fiscal policy shifts to a strong dollar policy. Central planners in Europe could see a drop in oil that would boost the recovery process. The global economy has seen a real run since 2008 with China and emerging markets leading the way. China could be a bubble unless a social revolution brings about governmental reforms. In the end I just do not believe Chinese data is consistently truthful.

U.S. Political

2014 is an important year in American politics, leadership and its base and just what do people see. The mid-term elections later in November will adjust both houses of Congress. The balance of power most likely will consolidate for one final push here. The final thrust of the Obama Presidency is at stake. The stakeholders in this vision will either see their vision completed in 2015 and 2016 or dealt a stalling blow. The question will the left leaning narrative spoken by world leaders continue into the next Presidential elections in 2016.

A more important issue at stake is the potential nomination of one or more Supreme Court justices out of the current Administration. If one of the current conservative justices say a Thomas or Scalia were to be replaced this would shift the political motive away from a pro business movement to a more State controlled view. This could have serious impact on market valuations longer term if a degree of extremity were to creep into the High Court. These particular justices are not Constitutional people, they represent a particular world view and their lense has already been shaped.

What are the potential pitfalls looking ahead?

• Peaking equity valuations
• Destabilizing emerging markets
• Regional war
• European Union
• Natural calamities disrupting supply chains

Where will the S&P 500 be at the end of 2014?

It depends on the following:

• The decision of the Fed in relation to liquidity injections
• Nations behaving badly
• Government regulation causing business costs to rise
• Interest rates
• Business confidence that further expansion in economic cycles will continue

I am expecting the market to shift into a more range bound outcome toward the end of 2014 and 2015. At some point I would expect a correction in the neighborhood of 12-14%. If Congress passes corporate tax reform and allows multinationals to repatriate earnings at a one-time rate of 10% or better this would be a new development not priced into the market. If sentiment changes during the last half of 2014 and breaks through 1640 on the S&P I would then expect a new range of between 1580 and 1680 before we go any higher longer term. So as of now I am forecasting a range in the S&P of between 1680 and 1840. So 1840 may be the highs and 1580 may be the lows at some point during 2014.

Where will the opportunities exist?

I like the potential of soft agricultural commodities such as corn, cotton and sugar. These were beaten down pretty good in 2013. These could be a nice play here in late winter. I do like oil at the right price. It seems like oil supply will be high in 2014 and 2015. A stabilizing WTI price around $75 to $85 a barrel is a nice floor. Perhaps gold if it continues it slide and begins building a base in the 1100 per ounce area. As sectors go for equities manufacturing could surprise as oil prices moderate. Healthcare and certain technology look appealing. I really like digital advertising, cell phone sectors, media and entertainment. Specific niche retail such as a Green Mountain Coffee Roasters will continue to rise. Broad retail may have a tough slog as consumers are changing their purchasing habits and those under 30 just do not have a lot of disposable income. Look for the niche companies that have brand appeal and pricing power.

One strategy that I am working on perfecting is short term investing in IPOs as they come to market. These companies can come to the market at attractive valuations. Which one is the next Linked In, Google, Facebook or Twitter no one really knows. One can get burned if you buy to early at too high an opening price. Some of the Chinese IPOs can be a good buy but they are risky.

As I look to the horizon many opportunities will emerge in 2014 and 2015. One must have the cash to take these opportunities. So begin saving and prepare to adjust your investing strategy. As Van Tharp says, “one does not trade the market, one trades on what you believe about the market” Belief shapes behavior and actions lead to gains or losses. I expect to see some volatility and a potential short position if the S&P gets too out in front as a hedge to a correcting market here in the summer 2014.

Note:

This is an editorial written to Horizon clients as part of our tax practice and economic advising toward healthy business practice.

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