All signs – as initially discussed below – point to a good year for equities in 2014. Of course, we are not deaf to the voices that talk about a stock market bubble, however and as we pointed out before we do not believe that we are dealing with a bubble, at least not now. Here are our arguments regarding the positive outlook for 2014.
Traditional models that focus on pricing trends as well as the CAPE (cyclically adjusted price-earnings ratio) and Q ratios, may be failing to incorporate the new institutional environment that is unfolding, where central banks play a different role than before and where the debt hangover has formulated an atmosphere of financial repression.
Sales margins are rising and the corresponding corporate profits are also on the rise.
Europe seems to be stabilizing, at least on the surface for the foreseeable future.
Liquidity is on the rise, given the new institutional rules governing the Fed’s repo agreements (see previous commentaries on the subject starting in late September).
Globally the other major players (China and Japan) seem to be following reform measures that increase collateral base and liquidity.
The coordination of the global collateral moves will increase collateral velocity and the latter money velocity.
The increased money velocity will translate into more loans and higher business turnover which in turn will advance businesses’ capital expenditures.
The higher capital expenditures will be viewed as a vote of confidence for a definitive business cycle upswing which will be followed by higher consumer spending.
Deleveraging appears to be declining.
New agreements such as the Volcker rule, the deal with Iran, and the WTO trade deal advance stability, reduce risks, liberalize business forces and allow capital to move and create new opportunities.
Any official tapering (we advocate that effective tapering starting on September 23rd with the Fed’s repo asset agreements) will be translated into a vote of confidence for the economy that “now can afford higher interest rates”.
The budget deal in Washington D.C. will push a sense that things are working again, even there!
Any stock market consolidation we see in December will simply allow equities to be bought at “more reasonable” levels in January.
All these signs and more to come in forthcoming commentaries point to what we call a Nirvana stage for equities for the time being.
Someone might object that this macro-list above may ignore realities of debt, unfunded liabilities, fiat money, effectively bankrupt nations, and so many other problems the global economy is facing and for which we have commented before. However, and in my humble opinion the institutional reforms that we are experiencing and the additional ones which might be underway resemble the era (1721-1734) when Montesquieu published his Persian Letters and his book on the fall of the Roman Empire (titled Considerations on the Causes of the Greatness of the Romans and their Decline). Those two books announced the age of Enlightenment and since then the world is not the same. With a foresight unlike any other Montesquieu analyzes the forces of devolution which may be inaugurated with the undergoing institutional changes. If the devolution forces are implemented and move forward then we could possibly avoid the brewing crisis.
For the moment we would be reserved to state that the emerging institutional environment plants the seeds among others for three paths that may intersect at some point in the near future, namely: Nirvana; Chimera crisis; and “controllable” inflationary uptick.
Maybe Led Zeppelin said it well in their “Stairway to Heaven” song:
And as we wind on down the road Our shadows taller than our soul. There walks a lady we all know Who shines white light and wants to show How everything still turns to gold. And if you listen very hard The tune will come to you at last. When all are one and one is all To be a rock and not to roll
And she’s buying a stairway to heaven.
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