It was a foregone conclusion that 2014 was not going to be as good as 2012 or 2013 when it comes to the stock market. The Federal Reserve has been warning for years that they were going to take the free money punch bowl off the economic table, at a time when Wall Street was getting used to being perpetually drunk on unlimited supplies of 0.25% cash. Like any junkie seeing their supply threatened, Wall Street started to panic.
Since the 22nd of January, the S&P 500 has dropped from 1,844 to 1,774, a 4% correction that surprised many people — and sent gold prices moving higher, as a few nervous investors sought to preserve their gains by switching to commodities. This correction is simply not going to last — and here are four reasons why.
The Fed Has Not Actually Raised Interest Rates
A little perspective goes a long way during times like this. The Federal Reserve has not raised interest rates, or even talked about raising rates in the near future. The Fed in fact only modestly trimmed the amount of stimulus money they were pumping into the economy. We’re a long way from the Federal Reserve pulling the tap on the free money keg, and the current Fed panic is premature.
There Is Still a Lot of Cash on the Sidelines
Even as the market was tipping into a losing streak, investors around the globe were dumping $6.6 billion into stock and mutual funds. Inflows to stock funds topped $16 billion so far this year. It’s estimated that there is still another $2.707 trillion dollars on the sidelines in money market funds. Even a modest return from the stock market is a better return than you’ll get from a money market account, which is, for all intents and purposes, 0% interest.
This chart from the St. Louis Fed tells the story of real GDP growth since the end of the recession. Notice it does not show the slightest hint of falling off at the top of the curve. In the third quarter of 2013, GDP was revised to 4.1% and the fourth quarter initial GDP numbers showed growth of 3.2%, though Q4 numbers are based on incomplete data.
Those are blowout GDP numbers that have many of the gloom-and-doom mongers in the financial media dragging out tired, old arguments about why GDP numbers don’t matter.
Corporate Earnings Are Still Strong
For all the woe in the financial media about corporate earnings, it’s good to remember that while not as good as the insane years of 2012 and 2013, in the context of history corporate earnings are still quite strong. When a company like Yahoo! can make $1.2 billion dollars in Q4 of 2013, and its stock gets raked over the coals because they didn’t make enough money, you know Wall Street has a serious problem with unreasonable expectations.
Corporate job cuts, and using free cash to buy back stock, were artificially inflating stock prices over the last five years. Going forward, corporate entities are going to be under more pressure by internal workloads to hire more people, and there will be pressure from society to pay workers a living wage. All of those factors will conspire to bring corporate profits back to something resembling reality.
Certainly unreasonable expectations will continue to influence perceptions of stock market performance but, when you cut through the noise, 2014 is still shaping up to be a pretty good year for stocks.