Last year was superlative for investors as the S&P 500 finished the year up by nearly 30 percent, the Dow jumped 26.5 percent and the technology heavy Nasdaq skyrocketed by 38.3 percent. After that jaw-dropping performance in 2013, this year has been something of a disappointment so far.
Stocks sold off sharply at the beginning of 2014, largely due to fears of slowing growth in the emerging markets. China has been a particular concern as manufacturing has slowed markedly of late as the country works to transition from an export powerhouse to a consumption-driven economy.
Quality of earnings has also been a concern here on our own shores, despite the fact that 7 out of 10 companies in the S&P 500 beat earnings estimates for the fourth quarter. Of the 82 S&P 500 companies that have reported first quarter earnings so far, fully two-thirds of them have shown earnings above the mean estimate; according to data provider FactSet, that's well below the 71 percent historical average.
While the pace of earnings beats is slowing, the real concern is languishing revenues. Earnings growth has outpaced revenue growth for several quarters now as cost-cutting and improved efficiency has driven higher profits. Of the reporting companies in the first quarter so far, there has been a 50-50 split between companies beating revenue estimates and missing them. On average, reported sales have come in 0.3 percent below expectations. Without growing revenue, how much longer can rising earnings last?
One of the heaviest weights, though, has been the Federal Reserve. While Chairwoman Janet Yellen has repeatedly said the Fed will provide as much support as the economy needs to sustain growth, she has also said that asset purchases will likely finish winding down in the fourth quarter, and hinted that interest rates may rise in 2015.
While on the face of it that should be relatively good news – it'! s a pretty clear indication that the Fed believes the economy is improving – I suspect it has the markets somewhat unnerved, considering rates have essentially been at zero percent for five years and it has been almost nine years since the last hike. It seems as though folks are worrying that any rate hike would bring this bull market to an end.
So far, though, we're yet to see a major correction and, historically speaking, a bull run has never ended after only the first bump up in interest rates. If the future holds true to the past, if Yellen et al increases rates sometime in the first half of next year as many seem to be predicting, that would actually put us about a third of the way through the bull cycle.
While market participants are clearly jittery, so far there aren't any clear signals that any of the major indexes are preparing to turn a corner. In fact, it looks like we're still following the template of years past when the Fed stayed too accommodative for too long. Initial jobless claims are back below pre-recession levels and even the housing market is almost back to where it was before everyone started flipping houses.
Odds are the Fed is going to end up creating another asset bubble as it did in 1993, helping to fuel the dot-com mania (anything looking familiar there?) and the trauma of the housing bubble in 2003. Add in the fact that the European Central Bank is likely to maintain its own accommodative stance to prevent deflation, the Bank of Japan is running a zero interest rate policy all of its own, and China is still deploying selective stimulus measures – another bubble is almost an inevitability.
Yes, a correction can and probably should come but the bulls will keep on running.
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