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What 2014 Could Mean for Your Portfolio

By Hal M. Bundrick

NEW YORK ( MainStreet) Since 2005, the American economy has been harnessed by slow growth, a deep recession and a glacial recovery. The 45-year average growth rate of 3.4% for inflation-adjusted GDP has become a distant memory, with U.S. annual economic expansion falling well short of that rate over the past eight years.

But that may be about to change. Dr. David Kelly, chief global strategist with J.P. Morgan Funds, sees "a good chance" that the economy will grow by more than 3.0% in 2014.

"While there are plenty of potential obstacles to even this modest achievement, growth at this pace should, to some extent, validate much of the stock market advance seen in recent years and set the stage for a further rise in interest rates," Kelly writes in a recent analysis. "The foundation for stronger growth lies in stronger consumer fundamentals. The last few years have seen a very significant rebuilding of consumer finances, with households now devoting less than 10% of their disposable income to servicing debt for the first time in at least 34 years."

Rising home and stock prices have bolstered household wealth to record highs, according to Kelly. "Barring some shock, consumers should be able to lead the economy to stronger growth in 2014," he says.

Kelly believes business spending will also increase and the housing market will continue its recovery. U.S. exports should also post "decent gains" on a somewhat stronger global economy.

With a projected 2 million new payroll jobs in 2014, Kelly expects the unemployment rate to dip to 6.5% by the end of the year.

Inflation will be held in check by subdued global energy prices. And as the American economy begins to hit its stride, the Federal Reserve will likely phase out bond purchases over the course of 2014, boosting interest rates further.

"This suggests that relative to their normal strategic allocation, investors may want to be a little underweight fixed income and keep the duration of their bond holdings relatively short," Kelly notes. "Second, a 3% [growth] economy is one that should allow earnings to continue to grow, providing further support for the stock market. However, it needs to be recognized that, after a 160% gain in the S&P 500 from its low in March of 2009, U.S. stocks no longer look cheap in absolute terms, but still look attractive relative to an environment of low inflation and low interest rates."

Kelly suggests investors may also want to consider adding to their overseas stock holdings to take advantage of attractive valuations. Potential risks to the upbeat 2014 outlook are possible setbacks in the Chinese economy, political instability in Europe and the Middle East and continued discord in Washington, D.C.