Markets Hit High in ’14 as Bull Run Endured
An accelerating United States economy trumped problems overseas to lift the stock market to new highs in 2014.
Despite losses for the day in light pre-holiday trading, the Standard & Poor’s 500-stock index closed on Wednesday with a gain of 11.39 percent for 2014 — 13.68 percent when reinvested dividends are included. It was the third consecutive year that the market benchmark has risen by more than 10 percent.
Other market measures also ended the year on a strong note. The Dow Jones industrial average closed up 7.52 percent for 2014, while the Nasdaq composite index ended up 13.4 percent.
Can the party in American stocks keep going in 2015?
“We don’t see a lot on the horizon that could derail the U.S. market in particular,” said Raymond Nolte, chief investment officer at SkyBridge Capital, an investment firm focused on hedge funds. “But there could be continued volatility.”
The market’s astonishing ascent began in early 2009, when the newly elected Obama administration was scrambling to revive the economy and right the teetering financial system. The run-up has now lasted nearly 70 months, making it the fourth-longest bull market since World War II, according to data from S.&P.
In recent months, investors have encountered deterrents that might have thwarted the market’s progress. The Federal Reserve, for instance, recently wound down its enormous bond-buying program, which had helped drive stocks higher. The economies of Europe and Japan remain fragile, despite big efforts to turn them around. The conflicts in Ukraine and the Middle East, as well as an unexpectedly steep plunge in oil prices, have gnawed at confidence.
Investors, however, appeared to anticipate that the United States economic recovery would gather pace in 2014. As that materialized in the second half of the year, the stock market kept rising, and was even able to bounce back from two big sell-offs, in October and early December.
Caution Despite Exuberance on Wall St.
The stock market rose again in 2014. But the rise in American stocks has made them more expensive. Stocks in 2014 (represented by the Russell 3000) were worth 143 percent of G.D.P., the highest year-end figure since 1999.
Percentage change in S. & P. 500 total return
since year end 2013
DEC. 30
+15.4%
+
15
%
+
10
+
5
0
–
5
J
F
M
A
M
J
J
A
S
O
N
D
2014
Market cap of the Russell 3000 index,
as a share of G.D.P.
THROUGH
DEC. 30*
143%
150
%
125
100
75
50
25
0
’94
’96
’98
’00
’02
’04
’06
’08
’10
’12
’14
On the year’s last trading day, the S.&P. was down 21.45 points, or a bit over 1 percent, at 2,058.90. The Dow dropped 160 points, or 0.9 percent, at 17,823.07, and the Nasdaq fell 41.39, or 0.87 percent, to 4,736.05.
But the losses didn’t dim the 2014 rally, which was remarkable for other reasons.
After 14 years, the S.&P. 500 finally, in late 2014, rose to a new high on an inflation-adjusted basis, according to data compiled by Professor Robert J. Shiller of Yale.
Retail investors, after sitting on the sidelines after the financial crisis of 2008, started to put money back in the market in 2013, allowing them to benefit from 2014’s advance. Increases in the value of stocks and mutual funds have led to over $7 trillion of gains to household wealth over the last three years, according to data from the Federal Reserve. But the wealthiest families have benefited more from the rally than middle-income households, since they have had a greater share of their savings invested in securities markets, according to recent research by Edward N. Wolff, an economics professor at New York University.
The stock market in 2014 also reflected significant shifts in the business world and wider society.
A torrent of corporate mergers, for instance, helped drive stocks higher. Allergan, the maker of Botox, was the target of a fierce takeover battle, which ultimately helped lift its shares 91 percent in 2014, the fourth-best in the S.&P. 500.
Alibaba, the dominant Chinese online retailer, executed the largest initial public offering ever in September, issuing $25 billion of stock on the New York Stock Exchange. Its shares are now 53 percent higher than the price at which they were offered.
The dominance of Facebook in people’s lives drove its strong stock market performance. Its ballooning profits, derived from advertising revenue, helped lift the company’s shares by 43 percent in 2014. But not all technology giants fared well. Shares of Amazon, for instance, plunged 22 percent, as doubts about its ability to generate profits deepened. IBM’s shares fell 14.5 percent as its long-term plans disappointed.
A near halving in the price of crude oil in 2014 was bad news for many energy companies. Shares of Halliburton, which provides products and services to energy firms, fell 22.5 percent in 2014. But the decline in the cost of fuel was a big boon for airlines. Southwest Airlines’ stock rocketed 125 percent in 2014, making it the top performer within the S.&P. 500.
Still, there were reasons to doubt the stock market’s roaring display.
The bond market, for instance, has not signaled the same optimism as the stock market. Economic strength typically causes government bonds to decline in price, pushing up their yields. Yet the yield on the 10-year Treasury note fell to 2.17 percent on Wednesday from 3.03 percent at the end of 2013 — a move that few analysts had forecast. Bond investors who did anticipate the decline in yields contend that strong forces within the economy will continue to limit growth. But a rise in yields in 2015 on the back of a strong economy may bring its own dangers. A spike in yields in 2013, for instance, shook global markets.
A sharp rise in Treasury yields in 2015 could step up the pace at which money is flowing out of developing countries. The exodus is damaging their economies and straining their financial systems. Such stresses could then become a hurdle for the United States economy.
“The biggest risk to developed markets is emerging markets,” said Atul Lele, chief investment officer at Deltec International Group.
A decrease in the appetite for riskier investments is also hitting American corporations, like highly indebted energy companies. A contraction in the energy sector could then end up hurting other parts of the economy.
In this environment, the spotlight on the fundamental performance of companies on the stock market will intensify in 2015. Many Wall Street analysts contend that the market is reasonably valued right now, arguing that corporate earnings support current stock prices. The stocks in the S.&P. 500 index, for instance, trade at close to 16 times the profits that analysts expect for 2015. That multiple is more or less in line with the historical average.
But the skeptics point to other measures. A measure of stock market valuation developed by Professor Shiller suggests that stocks are getting expensive. His so-called cyclically adjusted price-earnings ratio is currently 50 percent higher than its average level since the end of World War II.
A measure of valuation that Warren E. Buffett has cited is also flashing a warning sign. It compares the total value of the American stock market with the country’s gross domestic product. Right now, the companies in the Russell 3000 index are valued at close to $25 trillion, which is just over 40 percent higher than G.D.P. The last time that ratio was higher at year end was in 1999, the year before the stock market plummeted.
Profits may not be as strong as they look.
In recent years, companies have spent large amounts of cash buying back their shares. This reduces the number of shares a company has outstanding and thus bolsters its earnings-per-share, a measure of profitability that investors favor.
The question now is whether companies on the stock market have spent too much money on share buybacks and too little on improving the productivity of their own operations. In 2014, for instance, the companies in the S.&P. 500 bought back $438 billion of their own stock, according to data from FactSet. That sum is equivalent to 93 percent of the amount that the companies spent on their own capital expenditures. The 2014 percentage is higher than in any year since 2007.
The bulls argue that other measures of earnings power — like profit margins — look strong. But the skeptics say such metrics are also likely to weaken as costs rise.
“What we are looking forward to at some point is the combination of strongly rising interest rates and falling profits — and that is not a nice combination for markets,” said Andrew Smithers, the founder of Smithers & Company, an economics consulting firm.
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