Now that the Fed is likely to start taking its foot off of the gas pedal, pundits and investors are wondering if the rally can continue or if a meaningful correction looms.
Five years after the fall of Lehman Brothers and one of the steepest market corrections in modern history, stocks are trading near all-time highs; they are up over 150% since the March 2009 lows. Thank you, Uncle Ben; your loose monetary policy measures, generous asset purchases, and forceful intervention in credit markets have been the key drivers behind the market rally.
Now that the Fed is likely to start taking its foot off of the gas pedal, pundits and investors are wondering if the rally can continue or if a meaningful correction looms. Of course, I expect there to be a short-term market correction, and an overreaction to any news of asset purchase tapering or to news headlines proclaiming trouble in the Middle East or some other geopolitical crisis.
Putting these (very normal) short-term events aside, I believe that markets will test and ultimately set new highs. Moreover, I think 2014 could be another record year for stocks, and here’s why.
Market appreciation is driven by corporate earnings. 2013 S&P 500 (INDEXSP:.INX) earnings will likely come in around $112 to $114. This means that a 1,750 S&P would have a market multiple of just over 15 X, which is not cheap, but certainly not expensive.
Interest rates will likely rise enough to cause losses in bond portfolios, but they will not rise enough to make money market and fixed annuity investments attractive. This will likely drive investors to high-quality, high dividend-paying stocks.
Gold, silver, and other commodities will likely be underperformers as well, causing investors to shift their attention away from these investments and back to stocks. After all, we’ve all been conditioned to chase returns.
While central banks may tighten monetary policy slightly, they will remain extremely supportive. Fed tapering from $85 billion per month to $60 billion per month is hardly constrictive.
The global economic recovery will continue at its current modest pace, without meaningful inflationary pressures, wage pressures, or disruptions to the business cycle.
Although there are no guarantees, and vigilance is always appropriate, the stage appears set for another great year for stocks. Much like this time last year, when few investors believed that stocks could or would rise another 10% (the S&P was below 1,400 at this time last year), positive surprises are more likely than a prolonged correction. Smart and successful investors will recognize that the wind is in their sails and that they have the opportunity to invest in a relatively conservative portfolio of high-quality, dividend-paying stocks that should perform well over the next 12 to 18 months.
