As the Federal Reserve Board continues to throttle back its unprecedented bond buying program, it raises questions regarding the economic impact of less monetary accommodation. The old adage "Don't Fight the Fed" comes into play anytime monetary policy shifts. The U.S. central bank is clearly on a path to end its purchases of Treasury and mortgage-backed securities by November of this year. The Fed also has indicated it may raise the target Federal Funds Rate (currently 0.00 percent - 0.25 percent) six months later. For worried investors, less bond buying and rising interest rates could put pressure on asset valuations.
The reason for this eventual elimination of monetary accommodation, and the expectation of a rise in short-term interest rates, is the clear evidence that the U.S. economy has finally emerged from a long period of sub-par growth and is embarking on a more sustainable growth path. Despite the fact that the financial crisis-led recession ended nearly five years ago, economic growth has been hampered by the effect of the crisis on bank lending and a contraction of fiscal stimulus. Moving forward, we expect domestic GDP growth more in line of 2.5-3.5 percent annually, rather than the 1.5-2.5 percent experience of the past four years.
At the same time, we expect more-modest economic growth in the rest of the world. With China slowing down, growth in the rest of the world will depend importantly on the strength of the rebounds in Europe and Japan. Other emerging markets besides China -- such as Brazil, India and Russia -- are facing their own challenges, but overall we do not see recessionary forces at work in these regions at the present time. In total, we look for world economic growth in the 3-4 percent range for both 2014 and 2015. Doubtless there will be "wars and rumors of wars" to deal with, but by and large the forces of global integration and trade will continue to favor the optimists rather than the pessimists.
Craig J. Holston. PHOTO PROVIDED.
We expect the equity market to continue to show encouraging, though sometimes volatile, results over the coming months despite the occasionally unnerving headlines from places such as Russia, Crimea and Ukraine. Both the Euro-Zone debt crisis and fears of a Chinese economic hard landing have receded as policy makers in both parts of the globe seem to be resolving their respective issues positively. In addition, monetary policy outside the United States is getting more accommodative to combat slowing growth. The housing and auto recoveries we see in the United States are also positive "tailwinds" for domestic economic growth that were not in the picture three years ago.
Also on a positive note, the U.S. Congress has broken through its partisanship and prevented another government shutdown by agreeing to a budget not only for fiscal 2014 ending this September but also fiscal 2015 as well. In addition, they have avoided yet another fight regarding the debt ceiling. Finally, we also know who will lead the Federal Reserve going forward -- a selection we applaud.
We still expect to be pleasantly surprised by the improvement in equity valuations in 2014 and 2015 given the relatively low valuations compared to fixed-income alternatives. However, we caution investors not to expect returns in 2014 similar to last year. As always, being careful -- but not fearful -- is recommended. We remain comfortable with our outlook for moderate economic and profit growth in 2014-2015 on a worldwide basis -- which generally will set the stage for stable-to-rising equity valuations.