Last week, as we’ve been expecting, the market embarked on a well-deserved break. Much as many of us needed a little downtime following Thanksgiving dinner, the stock market is effectively digesting an extraordinary 2013. Predictably, the softness has brought out all manner of doomsayers ready to declare a crash (or worse) imminent. Many are pointing to the upcoming revival of budget and fiscal negotiations in Washington as the catalyst that will tip an already wobbly market off the edge, but we don’t think so. Neither the Democrats nor Republicans are interested in going through the public flaying that accompanied last time’s brinkmanship.
And no, it’s not a bubble. Bubbles seem to be everywhere these days, if you believe the pundits. We can remember when the word was said in hushed tones around the trading desks, and the only verified one was the technology craze in the late 1990s. Anyone around then can attest to how far away, for now, stocks are from that kind of environment. A strong advance does not indicate a bubble, and neither does high valuations; on the contrary, these things may simply reflect the healthy dose of optimism on which all multi-year bull markets are built. Bubbles, as every contrarian worth his or her salt knows, form when no one is looking for them.
Granted, stocks have been on a roll lately, up for eight weeks in a row and 11 of the last 13. In fact, they’ve been doing better than many would have thought possible given the range of weaker economic indicators that came in during the fall. But on balance, they’re not in nosebleed territory yet.
Remember, too, that less uncertainty – uncertainly about the budget mess, about tapering, about the economy, about ObamaCare, etc. – means higher valuations, since it boosts confidence. So as the fog lifts and investors can gauge the future more easily, it makes sense for valuations to expand.
And if you’re wondering where the fuel is coming from, look no further than bonds. Ever since “tapering” became the first word on everyone’s lips in July of last year, fixed-income investors have been steadily abandoning the bond market. Given that cash yields less than nothing on a real basis, the only alternative has been for these dollars to head into the stock market. By some estimates, some $2 trillion in worldwide fixed-income assets are vulnerable to tapering, so this shift is not even close to being over.
However, nothing goes in a straight line, and there are times when stocks get a little ahead of themselves. This is probably one of them. Add in the traditional profit taking and tax-loss maneuvering at this time of year, and we’re just not that surprised to see the markets taking a breather. Ultimately, it’s better – it suggests there is no strategic shift in trend taking place.
Economically, we think the path forward is fairly clear. Economists generally expect coordinated, albeit moderate, economic growth in 2014 - Europe has emerged from recession, fiscal and policy headwinds in the U.S. are easing, Japan is on the upswing and China’s economy has found better footing. As we’ve written before, 2014 will thus be the first year in ages that all four major economic blocs in the works are growing at the same time. This is significant, because it means the bull market is on solid ground. We doubt the pace of stocks’ advance will keep up with 2013, but it will remain positive.
In the background, the tapering of asset purchases continues to hang over markets. We’ll say one thing – QE may not have done much to spark the animal spirits of GDP growth, but it has certainly helped push up asset prices. Yet inflation continues to either decline outright or remain muted, suggesting easy monetary conditions are going to persist for some time. Indeed, if anything, the Fed and other central banks may be approaching a phase in which measures like QE are not only viewed as simulative measures, but also as a defense against deflation.
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The views expressed here are that of myself or the
cited individual or firm and do not constitute a recommendation,
solicitation, or offer by D2 Capital Management, LLC or its affiliates
to buy or sell any securities, futures, options or other financial
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clients, and its employees may or may not own any of the securities (or
their derivatives) mentioned in this article.
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