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At the end of February, the market as measured by the S&P 500 moved slightly above the year-end levels. Subsequently, a brief calming of the tensions surrounding the events in the Ukraine (time will tell) generated a relief rally that extended a bit further resulting in new record highs exactly 5 years after the financial crisis lows of March 2009.
Recently the S&P 500 dipped below its closing level on Dec 31. The combination of unrest in the Ukraine economic setbacks in China has not yet proved to be the catalyst for a serious market decline.Ultimately market participants will have to address the stock market bubble that has inflated since last summer. When this happens we will get our opportunity to invest at reasonable (and hopefully even cheaper) prices.
As it stands, the bulls and bears agree on two things; stock prices this year will be driven by growth in the economy, and inflation is unlikely to rise in 2014. We are convinced that both of those premises are wrong. The bullish majority believes stock prices will rise in response faster US growth, while the bearish minority expects disappointing growth to drag stocks lower. With both camps expecting stock prices to track the economy synchronously, the market is moving up or down with each new economic data point. Don’t plan on this continuing.
Over very long periods of time (say a decade or more) stock prices usually mirror economic growth. During shorter periods (say any given year), history shows no such correlation. For instance, the divergence between the stock market growth and real economic growth last year was over 27%. Although some wild card event (like Ukraine or China) may be the catalyst for the correction, rising inflation will be the true Achilles’ Heel of the markets. Over the past few years stagnant wages have kept inflation dormant and bolstered corporate profits. Recently, despite a weather-depressed economy, hourly wages (a primary driver of inflation) have started to rise sharply.
This should come as good news. Firstly, most Americans pay bills with our wages; wages that are rising. Secondly, we believe even the bulls are grossly underestimating US economic growth in 2014. Faster growth means that wages, inflation and (to a lesser degree) interest rates are likely to rise more rapidly than the bulls anticipate. Stock prices are not necessarily correlated with the economy in the current year. Stock prices are however a decent predictor of next year’s economy (as is the slope of the yield curve). The outsized stock gains of past 18 months, as well as a steep yield curve (long-term rates higher than short-term rates) support our expectation of rapid growth and higher inflation in 2014.
2.20.14 - February Flash Update
1.15.14 - 2014 Annual Forecast
12.10.13 - Bursting of the Bond Bubble
11.13.13 - A New Top for Stocks?
7.23.13 - Bursting of the Bond Bubble
5.9.13 - The TINA Hypothesis
4.15.13 - The Bernanke Illusion
3.15.13 - US Economic Outlook
2.1.13 - 2013 Annual Forecast
12.10.12 - Tax Reform: A First Step
9.17.12 - QE3
5.1.12 - All the Good Ones Are Taken
3.12.12 - March Flash Update
2.23.12 - February Flash Update