First Quarter 2014 Market Review
Volatility and a higher level of anxiety returned to the markets during the first quarter. The primary catalysts were the “evil empire’s” invasion of Crimea and a severe slowdown in the economy induced by colder than normal temperatures. The inclement weather kept consumers away from the shopping malls and Russia’s political aggressions clearly detracted from investor confidence. Fortunately, business conditions appear to be getting better with the cold weather behind us and the political issues could be dealt with by adopting some intelligent U.S. energy policies.
Value stocks clearly outperformed growth stocks during the period while midcap stocks outperformed both large and small stocks. Following several months of underperformance, utility stocks posted the best sector gains for the period and consumer discretionary stocks performed the worst, reflecting the sharp drop in economic growth.
Despite the economic slowdown, the majority of corporate earnings reported were above expectations and analysts have recently been raising their numbers for the second quarter. Overall, the market moved modestly higher during the quarter. The S&P 500 increased 1.8%. With business conditions sluggish, interest rates declined during the quarter and this provided a rebound in bond prices following last year’s 0.86% decline, the first fall-off that has occurred since the mid-1980s.
There seems to be a much higher than normal number of people calling for a severe market correction. One of the reasons often cited by naysayers is that the market is too expensive and therefore vulnerable to a bear market. The most recent earnings estimate published for the S&P 500 is $121.86 and at today’s stock prices, the market sells at a PE of 15.8x compared to 18.8x during the last market peak in 2007.
History shows that major downward moves are primarily influenced by economic recessions, not by valuation. The soft first quarter was a temporary weather-induced setback from the uptrend; recent activity has clearly improved; and with excess capacity available and no labor shortages, higher inflation is not a threat for the Federal Reserve to contend with. While this is not to say that we can’t have a meaningful correction, it’s difficult to see a full-fledged bear market on the immediate horizon.