MARKET BUBBLE OR PEAK OF IRRATIONAL PESSIMISM?
We have had our 3rd straight quarter of US corporate revenue and earnings growth. The global recovery continues as one more BEAR or negative analyst /money manager gives up and is at least “bullish into the early part of 2014." Pessimism still reigns with the most stalwart of Bears holding to the premise -" the rise in the stock market has been due primarily to the Federal Reserve stimulus." Of course, the US has increasing federal debt mostly due to entitlements - ever broadly defined. However, given the current economic cycle and the reprieve the US and the dollar have received as a result of other countries' woes, perhaps our debt crisis is not at hand - yet. Fortunately, the US has been given time to change our fiscal trajectory! It's a very short term, historically fast moving market and we need to be open to the current economic cycle. Sentiment - too negative or too positive- should not govern investment allocation. Unbiased examination of the investment and global economic environment coupled with one's personal investment policy /risk tolerance suggests appropriate holdings.
The market's value is fairly priced based on a formula using a little optimism and honest acceptance of the improving global economic data. Prior to interest rates normalizing, expect some volatility /downward pressure on stock values but be open to adding to select positions in 2014. After about 5 years of outflow /selling stock mutual funds, 2013 is the first year of net inflow/purchases of stock funds. Would this flow reverse just after one year? (Certainly possible but is unlikely). The trends of interest rates rising and bond selling should continue to result in increased allocation to stocks. Dysfunction in Washington is working. The drag on the consumer due to tax hikes will be dropping out. Unemployment has reduced more than expected. The Federal Reserve reflation is working; they keep moving the goal post of unemployment. Perhaps the end of the taper (spending/printing money) will be by December of 2014. Despite the government shutdown, unemployment was not increased as much as expected. Wet weather- one of the rainiest - this past spring/summer had a negative effect on hiring in the 3rd quarter. The returning noise from politicians will most likely be muted as both parties look to picking their battles anticipating the mid-term elections. In hindsight, the Federal Reserve could have tapered in September and may be behind schedule which could add to volatility. It's doubtful tapering will start in December (no one likes to be a Grinch) but early 2014 is likely. The nature of accommodation is to error on the conservative side - to delay the taper.
All 10 major US domestic sectors are up 10% or more this year. The Global economy and interest sensitive sectors – industrial, technology, and energy should continue to accelerate in 2014 along with a substantial increase in capital investment. Europe, specifically Germany, is a road block to increasing global growth due to reluctance to stimulus/lowering rates- “trashing ” the euro - that is required to get/keep Europe out of a recession. Austerity (raising taxes, cutting government spending) is not working and perhaps with Germany's Merkel and her coalition getting in place, they will get it right. Reform in China, although really not serious or material, is a step in a positive direction. Japan is on-line and adding to the global economy. The US is ready to overtake Russia in energy production with the biggest story being natural gas exports. Immigration reform appears stagnant but would be positive for the US economy. US Trade is also an issue with the Trans Pacific Trade Agreement on the rocks. States continue to struggle with underfunded pension funds, lower tax bases, and high unemployment. However, many state governments have made fiscal progress and are less of a head wind to a growing US private sector; zero state government growth vs. negative growth is a plus. In fact, just factoring in more muted effects of tax increases, federal government sequester/spending cuts, and less contracting state governments, suggests a private sector growing at 3 to even 4%.
Federal Reserve tapering will reduce “bubbling” but should allow continued growth of this bull market into 2014. Appearance of progress in Iran is good for the US consumer via lower prices at the pump. This should ease concerns regarding a flat to mild increase in holiday spending. 5-6% increases in corporate earnings in 2014 should be reasonable. Based on history, this would not be an exceptional expectation.
Steve Erken, CFP
Principal
November 26th, 2013