In yesterday's post on the market's technicals I described the stocks as "bubble eligible".
Since the autumn 2011 low, the SPX is up over 67%. This reflects modest economic and
earnings growth coupled with a sharp deceleration of inflation which has reduced the discount
rate for stocks and sharply boosted the p/e ratio. On top, the Fed has kept short rates negligible
and has flooded the system with liquidity through its aggressive QE 3 program. Logic would
suggest further modest economic growth, continued very low inflation, ZIRP and ongoing QE
could well keep the market on a bubble trajectory, other things held equal. However, if the
US and the large remainder of the global economy can maintain or even increase the recent
faster pace of real growth, then inflation pressure may be elevated and the Fed and perhaps
other central banks would curtail and, perhaps, ultimately eliminate the large liquidity
infusions. In this case, earnings performance should improve markedly, but there could well
be downward adjustments to the market's price / earnings multiple to reflect faster inflation
as well as a diminishing speculative interest as the QE tailwind for the market fizzles.
Looking at 2014, there will be less fiscal restraint both regarding spending and taxes and this
development should strengthen basic US economic potential. The trend of the momentum of
my coincident economic indicators has recently turned up, and it is good to see that the
weekly leading economic indicators have continued to move higher since Q 3 '12. So, as we
move into 2014, there is enough economic promise to look for somewhat higher inflation
and to expect the Fed may maintain a QE taper program, at least for a while. The implication
here is that investors may need to prepare to see some p/e ratio erosion as well as a bit of
leakage away from US equities to offshore stock markets and, perhaps, commodities and PMs.
Looking out through mid - 2015, the critical issue is to have determined whether the US
economic expansion can sustain itself without QE and the promise of negligible short rates
for years to come. If not, a sharply elevated market based on more QE and ZIRP will
eventually be seen as a Potemkin Village on Wall Street.
- Peter Richardson
- Retired chief investment officer and former NYSE firm partner with 50 plus years experience in field as analyst / economist, portfolio manager / trader, and CIO who has superb track record with multi $billion equities and fixed income portfolios. Advanced degrees, CFA. Having done much professional writing as a young guy, I now have a cryptic style. 40 years down on and around The Street confirms: CAVEAT EMPTOR IN SPADES !!!