2014 Economic Crystal Ball

It’s tricky business to make economic and financial market predictions, which is why I avoid dusting off the ol’ crystal ball. Instead, I talk to the smartest people that I know to come up with best guesstimates for what the year has in store for us. Economic growth: Will this be the year the economy finally accelerates to the post-World War II average of 3.3 percent? Well, maybe not for the entire year, but 2014 is likely to be better that what we have seen thus far in the recovery. As a reminder, during the recession, real GDP contracted by 0.3 percent in 2008 and by 2.8 percent in 2009. The recovery years have been OK, though not sterling, with the economy expanding by about 2.25 percent annually from 2010 through 2013.

Last year, growth was restrained by the double-whammy of fiscal policies, which increased taxes on wages for Social Security and on income for wealthy Americans; and by sequestration, which reduced government spending. The Congressional Budget Office estimated that the combination reduced 2013 growth from what would have been above 3 percent, to the recent trend growth rate of 2.25 percent.

This year, the economy should shift into a higher gear, as consumers spend more on the back of an improving labor market and gains in stock and housing prices; and businesses start to spend some of the of $1.8 trillion of the cash on hand. Economists see growth of 2.5 percent early in the year, rising to 3 percent by the end of the year, which would be the fastest since 2004.

Jobs: It has been a rough eight years for the labor market. After a devastating recession vaporized 8.6 million jobs, employment still remains 1 percent below the pre-recession peak. In each of the last three years, monthly job creation has averaged about 175,000 to 185,000. The good news is that there was a noticeable acceleration towards the end of 2013; and with an overall pickup in the economy, estimates are for 2014 monthly job creation to be 225,000. At that level of job creation, the unemployment rate should drop steadily towards 6 percent by the end of the year.

Housing: 2013 was a big turning point for the US real estate market, due to a combination of low interests rates, bargain-basement prices, fewer foreclosures and a subtle shift in buyer psychology. The result was a more than 13 percent increase in national home prices for the year. The pace of price gains will likely slow in 2014, due to higher mortgage rates and an increase in inventory, with estimates for mid-single-digit increases.

Investors: After a year when U.S. stocks soared by more than 30 percent, few are predicting similar results for 2014. That said, the bulls note that individual investors are still sitting on trillions of dollars in cash, which could push up indexes by 8 percent or so in 2014. Bears say that the current bull market has already gone on longer than expected and with the Federal Reserve reducing its stimulus in the year ahead and interest rates slowly rising, stock and bond investors will likely have a tough year.

What could go wrong? Remember Europe? A look ahead wouldn’t be complete without mentioning that while conditions have improved across the pond, there are still fundamental issues with the Euro. Then of course there are U.S. politicians, who could replay the debt ceiling debacle and the usual geopolitical risks. But the biggest risk would have to be the Federal Reserve, which is walking a fine line in attempting to undo a major policy initiative. If the central bank reduces its bond purchases too quickly, the economy could falter and investors could get spooked. Conversely, going too slowly might create a speculative bubble.