This week I’ve been writing about the potential for a major reversal of the stock market this year in Gravity – The Stock Market’s Mortal Enemy, and how it wreaks havoc for small investors in particular. In the interest of balance – and to concede that my opinions on the direction of the stock market are subject to my own biases – today I’d like to take the other side of the argument. Here are five reasons why 2014 may be another great year in the stock market.
Lower interest rates alone could cause a great year in the stock market
Investors, and especially economists and politicians, tend to focus on the economic benefits of lower interest rates. The effect on stock prices is seen as mostly incidental. In reality, interest rates are at the heart of the rise and fall of the stock market at nearly any time.
It’s not just that lower interest rates theoretically improve the economy, and thereby raise corporate profits. Fixed income investments compete directly with stocks for the investors dollars. Low interest rates mean that fixed rate investments are less competitive with stocks. Why invest money in certificates of deposit at 1%, when you can get double-digit returns in stocks?
And when interest rates are that low, that’s exactly what most investors choose to do. This is probably the main reason why the stock market has been rising continuously for nearly 5 years.
Should the Federal Reserve decide to force rates back down to record lows, the stock market could set a new succession of record highs.
An increase in Quantitative Easing
Much of what caused interest rates to rise in recent months has been the announcement by the Federal Reserve that they would taper Quantitative Easing (QE). The taper was just $10 billion per month, lowering QE from $85 billion, to $75 billion. Simply restoring to QE to $85 billion would probably be very bullish for stocks. An increase above that level will be even more so.
Not only has QE been keeping interest rates low, but it has also increased liquidity in the economy (which is why interest rates are low), as the Federal Reserve has bought up both US Government Treasury debt, and mortgage bonds. The money that has not been going into these debt securities from private sources is largely ending up in the stock market, fueling higher prices.
A weakening economy
It should be obvious that Wall Street detached itself from the Main Street economy a long time ago. Despite the very weak economic recovery since 2009, the stock market has been rising steadily to record highs ever since.
Clearly, a weak economy won’t spook the stock market. In fact, the opposite is probably much more true. Since the Federal Reserve is likely to both increase Quantitative Easing, and lower interest rates, in the face of a weakening economy, the stock market is likely to go on another upside rampage at any sign of economic decline.
There’s not much to say here beyond the fact that historically, the stock market loves a good war. There are several reasons for this, even if it offends the sensibilities of the average person:
- War creates demand for military hardware and munitions
- War increases spending in general – even beyond the war effort
- Government spending is less restrained during war. Wall Street doesn’t oppose government spending the way some people would like to think it does – largely because much of it increases corporate profits
- War tends to unite public opinion – at least in the early going. That has a way of making other uncomfortable issues look less threatening
- Government takes definitive action during a war, and Wall Street loves when government takes definitive action. It increases the sense of certainty that the stock market thrives on
The arrival of a game changing technology or energy source
This is an “X factor” that is impossible to predict before the fact. One of the restraints on the economy right now is that cheap energy sources are becoming scarce. As the cost of energy rises, the cost of doing business goes up, and profits go down. If a potentially large source of predictably inexpensive energy were to be discovered, it could have a major positive effect on the stock market.
Not only would this mean a return to cheap energy, but it would also mean the development of entirely new industries.
Alternatively, or even related to a major energy find, would be the arrival of a game changing technology. This could form the nucleus of a major growth industry – something that has been seriously lacking in the recovery from the Great Recession. Not only will that facilitate capital formation, new construction, more jobs, and higher profits, but it might also cause a surge in optimism. And when people feel more optimistic, it tends to have a positive effect on the stock market.
I’m not saying that any of these possibilities are likely to materialize during 2014. But I am pointing out that any one of them, or a combination of several, could keep the stock market steaming forward, despite the most pessimistic assumptions – including mine.
How do you think the stock market will fare in 2014? Are your projections changing your behavior in any way?