Treading Water: Four Economic & Market Trends Likely to Continue in 2014

by on February 26, 2014

Though there was quite a bit of back-and-forth stock market movement last week as investors reacted to some mixed economic data and earnings reports, stocks ultimately finished the week little changed.

Like stocks, economic fundamentals are also treading water, and I see more of the same ahead. As I write in my new weekly lifesavercommentary, I expect a number of key economic and market trends to continue in the coming months.

Low inflation. Last week’s January’s Consumer Price Index reading showed that inflation remains well contained. Two factors are helping to keep inflation contained and less volatile than in the past – soft wage growth and dampened oil price volatility. If wage growth stays soft, I don’t expect to see any near-term acceleration in inflation.

Low rates. Low inflation is good news for the economy, and for markets. It means that the Fed is under no immediate pressure to raise rates, and we expect short-term rates to remain low for the remainder of 2014 and into 2015.

Moderately higher market volatility. The VIX Index, a measure of U.S. stock market volatility, has fallen a bit since it spiked in early February, but it’s higher than it was at the start of the year.

Given the uncertainty surrounding the U.S. economy, the Fed’s tapering, and the still fragile environment in emerging markets, I expect the relatively higher levels of equity market volatility to persist. To be clear, I’m not forecasting unusually high levels of volatility; rather, I anticipate volatility will continue to rise from what have been unusually low levels. Specifically, I expect the VIX to head from its current level of just under 15 back toward its long-term average of around 20.

More M&A activity. Corporate deal activity has been on the rise in recent weeks. In a world of relatively slow growth, and fewer opportunities for organic growth, it’s no surprise that companies are willing to deploy cash and in some cases rich stock valuations – to buy growth. The willingness to engage in mergers and acquisitions may also be a precursor to rising capital spending.

So what does this mean for investors? Low rates should support equity valuations and help keep long-term Treasury rates from rising too aggressively. In addition, higher levels of deal activity and higher capital spending levels also tend to act as tailwinds for equity markets. You can read more about my economic outlook in my latest Investment Directions monthly market commentary.

Russ Koesterich, CFA, is the Chief Investment Strategist for BlackRock and iShares Chief Global Investment Strategist. He is a regular contributor to The Blog.

Source: Bloomberg, BlackRock research