6 Reasons to be constructive on the Equity Market

by Laura Ehrenberg-Chesler on January 9, 2014

in Debt,Economic Indicators,Energy,equity market,Fiscal Policy,Foreign Markets,interest rates,taxes

I thought a great way to start my first blog of 2014 was to quote our favorite economist, Ed Yardeni. “(1) Better growth. I’m hearing more talk about possible upside surprises for real GDP growth. The “Old Normal” growth rate of 3% might make a comeback. It’s been fluctuating around the “New Normal” growth rate of 2% since 2010 (Fig. 5). The bears have been warning that such a low growth rate was the economy’s “stall speed.” Whenever it was that low, a recession followed. They’ve been wrong. I countered that excluding government spending, the private sector’s real GDP was still growing around 3% (Fig. 6). The latest data show that real GDP rose 2.0% and 3.1% y/y during Q3-2013 including and excluding government spending. (2) Less fiscal drag. There was certainly lots of fiscal drag from state and local governments, which were forced to reduce their spending during and following the Great Recession as their tax receipts fell (Fig. 7). But the worst seems to be over, with their spending rising 1.7% (saar) during Q3-2013. Federal government spending in real GDP remained weak last year, and surely won’t be a source of growth this year. But last year started with some significant tax hikes for payroll employees and upper-income taxpayers that won’t be repeated this year (Fig. 8). Debbie and I still have some concerns about fiscal drag from Obamacare, but it’s hard to quantify. (3) More domestic energy. Following the end of the Cold War, there was much talk about the coming Peace Dividend. It probably did contribute to growth during the 1990s, but then the 9/11 attacks led to America’s wars in Afghanistan and Iraq. Now we can look forward to the Fracking Dividend. It is already having a dramatic impact on lowering America’s dependence on foreign oil (Fig. 9). In fact, there is mounting industry pressure on the government to permit the export of crude oil, which has been banned since the energy crisis of the mid-1970s. There is no ban on the export of petroleum products. The result has been a surge in such exports recently, while imports of both crude oil and petroleum products remain on a downward trend. The Fracking Dividend has already narrowed this US petroleum trade deficit from a recent peak of $359 billion (saar) during January 2012 to $182 billion during November 2013 (Fig. 10). The deficit could go to zero over the next couple of years. That would provide a big dividend to real GDP growth, as well as more purchasing power for Americans. Building the

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infrastructure to export crude oil would be another benefit, especially for capital goods manufacturers. (4) Tolerating tapering. One of last year’s anxiety-provoking issues was whether QE tapering by the Fed would put an end to the bull market in stocks. It certainly seems to have done so for bonds, as tapering talk pushed the yield on the 10-year Treasury from a low of 1.66% on May 2, 2013 to about 3% after the FOMC announced last month that bond purchases would be reduced from $85 billion to $75 billion per month. Fed officials have insisted that tapering isn’t tightening. In his most recent speech, on January 3, outgoing Fed Chairman Ben Bernanke said: “In particular, the FOMC’s decision to modestly reduce the pace of asset purchases at its December meeting did not indicate any diminution of its commitment to maintain a highly accommodative monetary policy for as long as needed.” The financial markets seem to be getting the message, and tolerating tapering. (5) Recovery in Europe. Last year was the first year since the Greek crisis started in late 2009 that investors no longer feared that a “Grexit” or some other calamity in the Eurozone’s peripheral countries would lead to the disintegration of the monetary union and to a Lehman-style financial collapse. European stock markets have been on an upward trajectory since the spring of 2012, as investors gained confidence in the financial stability that followed ECB President Mario Draghi’s pledge at the end of July 2012 to do whatever it takes to defend the euro. Last summer, there was mounting evidence that economic activity was recovering in the Eurozone following a six-quarter recession that started during Q4-2011. However, it has been a very weak recovery so far. Yet it is a recovery, which is better than a recession. Perhaps it will pick up some steam this year, according to my reading of the consensus outlook. (6) China’s debt fix. There is a growing confidence that the Chinese government will do whatever it takes to keep the economy growing and to avoid a hard landing. An official audit published on Monday found that local government debt levels have soared 70% to almost $3 trillion in less than three years. Roughly 40% of it will mature before the end of this year.” We agree with Mr. Yardeni, and have blogged often about some of these very same fundamentals. 2014 could be better than expected.      

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