To say 2013 is a surprising year for US stocks is a pretty gross understatement. The good news is that we do not seem to be slipping back into recession-instead we are experiencing painfully slow improvement in our economy. We are looking at an anemic growth rate for our economy of around 2% and very slow job growth. To look at US market growth versus earnings growth of stocks during the year leaves you with an inconvenient truth-most of the surge in markets is from valuations increasing rather than earnings increasing. So, simply put, investors are paying more and more to purchase a dollars’ worth of earnings. Stocks are getting more expensive, but the momentum of moving into stocks is strong and growing. That brings us to some disquieting possibilities.
What is next as we look to 2014? In his most recent opinion piece, Jeremy Grantham pointed out that we do not have signs indicating that we seem to be in the midst of a bubble. There is still plenty of money on the sidelines and it is not yet cascading into stocks. Based on that, he predicts we could see an upside move of 20-30% in the next year or two. After that, Grantham sees another epic market fall.
Our take on that is……if we continue to see a market melt up similar to this year, yes, we are forming a bubble between prices and values which will likely end badly for all investors. The positive alternative would be a rather stagnant market with limited gains that more closely reflect earnings growth.
Investors seem to be forgetting what normal markets look like. A 5% correction is a normal occurrence every seven or eight months in a bull market, according to Jim Stack in a September Forbes’ article. So, markets will likely continue to have the two steps forward, one step backward progression that is the norm.
This is the first year in a very long time where money is actually flowing into stocks rather than away from them. The danger is if money begins to cascade into stocks from other areas that are disappointing investors (e.g. bonds and cash alternatives), a cascade could cause the markets to run up another 20 or 30 per cent rather quickly. If we see that, it is Shakespeare’s “double, double toil and trouble”.
By Ted Schwartz, CFP©