It's often said bull markets climb a wall of worry, and 2014 was no exception-stocks rose as investors fretted things old and new. At this time last year, we took a stab at guessing the 14 false fears likeliest to plague investors. Some, like the eurozone crisis's resurrected ghosts, did say "boo!" Some morphed-Fed "taper" terror gave way to rate hike hysteria. Others, like the debt ceiling or Affordable Care Act confusion, vanished as newcomers-like Ebola-took their place. Here we give you the full recap of 2014's wall of worry-and a glimpse at what folks still fret as 2015 dawns.
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Throughout this bull market, many claimed stocks were rising solely due to the Fed's quantitative easing (QE) bond purchases-and feared the bull would end when QE stopped.
But as we type, QE is over and the bull market and economic expansion aren't. The US not only continued growing, it accelerated as the Fed wound down QE. Seems to us QE was more an economic depressant than a stimulant-its conclusion is a plus.
Others argued QE drove "hot money" to EMs, and the end of QE would reverse this-roiling EM economies. Many pointed to some EM's January wobbles as proof this was right.
But as we pointed out then, EM volatility was limited to just a few countries dealing with localized issues-Fed policy didn't drive Turkey's political unrest or South Africa's commodity-dependence. Evidence supporting the theory a tidal wave of cash flooded EMs is lacking. EM stocks have trailed the developed world since 2011. You might expect hotter returns if the hot money surge were real. The EM story in 2014 was more one of country-specific factors, reforms and industry concentration affecting economic and market performance.
Will rates still stay low for "a considerable time?" Or is the hike nigh? That was THE question after quantitative easing ended! Analysts furiously diagrammed the Fed's sentences for clues to the next hike's timing, which presumes rate hikes present a major problem for stocks. Some suggest they are a bigger threat now because rates have been at 0% - 0.25% for six-plus years.
We believe these fears are overdone. The first rate hike in a tightening cycle has no history of automatic negativity for the economy or stocks-and we have no reason to believe this time is different. An economy growing above-average five years into an expansion with forward-looking indicators also signaling growth can probably handle rates modestly above zero. Plus, the Federal Open Market Committee presently comprises 10 individuals[i]-trying to game how 10 people[ii] will vote on an issue is futile.
This was the year monetary policy allegedly inflated stocks and things, momentum investors inflated Biotech and social media and yield-chasers inflated junk bonds. But in our view, folks mostly conflated normal market volatility with bubble behavior. Despite springtime dips, Biotech and Tech rose double digits year-to-date. High-yield bonds did have plenty of buyers, but the spreads between high-yield corporate debt and US Treasurys remain within historic norms-not indicative of investors eschewing risk and piling into junk. Ironically, if many folks are on bubble watch, that's a sign of skepticism, not euphoria. Bubbles usually feature widespread defense of irrational optimism. We don't see that today.
Headlines try to stir the slumbering eurozone crisis, hyping old ghosts like Italy and Greece's recent political upheaval or Germany's courtroom challenges against bailout measures. Yet all have thus far had very little impact on global stocks or the economy, and in our view, they aren't likely to moving forward. False fears lose power over time, and this one is getting pretty tired.
The other euro fear: deflationary depression. FACT: The eurozone doesn't have broad deflation. It has disinflation or just low inflation, which is echoed by the US and UK. Yes, headline inflation slowed to 0.3% y/y in November-but core inflation (excluding energy and food) hit 0.6%. There is no minus sign preceding those figures. Money supply is growing, not shrinking. Falling energy prices are the biggest weight on headline CPI-not a sign of huge problems ahead, and something consumers enjoy. Oh, and the eurozone is actually slowly growing-not gangbusters, but it likely needn't skyrocket for the 18-nation bloc[iii] to best low expectations.
2014 began amid fears the government wouldn't back credit-crunched banks. When that fear's shelf life ended, worries morphed to banks' exposure to allegedly troubled local government debt-just as China crisis and hard-landing fears have morphed since 2011-ish. All along, GDP growth has slowed, but to a still healthy 7%+ clip. Banks have received whatever support they needed, even as the government tried to nudge them away from certain practices. China's rulers have the means and the incentive to keep things going, as evidenced by their targeted stimulus measures.
Midterms ensured more gridlock, pairing a Republican Congress with a Democratic President, pleasing pretty much no one. But continued gridlock is a plus for stocks. Folks fret a do-nothing government, but it reduces the likelihood extreme, contentious legislation materially affecting stocks passes. Stocks typically greet gridlock with positive returns. History shows stocks rise in 86.4% of midterm election year Q4s and the subsequent two quarters, far above the typical quarterly average.
Perma-slow growth jitters gained traction when GDP contracted in Q1, but that proved to be a blip. Moreover, growth was speeding before that -2.1% Q1 weather-related dip aside. In the last five quarters, US GDP has grown 4.5%, 3.5%, -2.1%, 4.6% and 5.0%.[iv]Four of those exceed the US's postwar average 3.3% rate, which should call into question all those theories that rising stocks don't match a stagnant US economy.
Fears of dollar's demise as the world's preferred reserve currency flipped to concerns about the stronger dollar, which folks feared could hurt growth by making exports more expensive. Yet there isn't much history suggesting a rising currency really crushes exports-it may affect growth on the margins, but that's about it. And stocks have risen fine whether the dollar was "strong" or "weak."
Others fretted the stronger dollar meant EM doom-especially after the Russian ruble tanked in December (compounding a slide that began in June as oil prices started falling). Some fret a 1998 Russian ruble crisis redux, but there are more differences than similarities between then and now. Today, the ruble isn't pegged to the dollar and its dollar-denominated debt service is more than covered by forex reserves over the foreseeable future, neutering two major reasons Russia defaulted in 1998. Besides, while Russia's 1998 default may have contributed to a large global correction, it came and went fast, with global markets ending the year 24%.
A false fear for every year. In 2014, it was Russia and Ukraine (and resulting sanctions). Syria. The Islamic State of Iraq and al-Sham (ISIS) sweeping through northwestern Iraq. While some short-term volatility arose, stocks were overall resilient. This is typical: Regional conflicts historically don't have a lasting market impact. Unless the conflict escalates globally-like World War II-it likely lacks the power to derail a bull market.
Ebola spread outside Africa in October, triggering fears this scourge of West Africa would become a pandemic. It hasn't to date, seeming a little more like 2009's Swine Flu scare in terms of scope. But even in the tragic event Ebola does spread, there is just no history of disease affecting markets. Take, for example, 1918's Spanish flu, which killed millions worldwide. Sketchy but available data show stocks rose.
Some worry falling oil prices will cause the US shale oil boom to slow, removing a nice US economic tailwind. But oil firms are used to big price swings, and considering oil wells' massive upfront costs, they aren't likely to slash production immediately. Plus, many firms hedge against price swings using futures, giving them breathing room to ride out periods like this for a while. Some companies may alter exploration plans, but prices must stay low for a while to knock production.
You don't need us to tell you at least half of these fears persist. Euphoria is still quite a distance away! When folks are punch drunk, it'd be easier to find 14 hyped hopes than 14 false fears.
Stock Market Outlook
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[i] It is usually 12, but two seats are open now because gridlock.
[iii] Soon to be 19. Hello, Lithuania, country with the greatest Olympic basketball team artwork of all time!
[iv]US Bureau of Economic Analysis, as of 12/31/2014. Real US GDP growth at seasonally adjusted annual rates, Q3 2013 - Q3 2014.
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