Originally published in the Daily Journal of Commerce, Portland OR
March 10, 2014

William RutherfordAfter an uncertain start to the new year, the S&P gained 4.3 percent in February to reach 1,859.45 and close the month at a record high. The February performance was the S&P’s best since 1998 and second best since 1991. The Dow Jones average gained 4 percent to 16,321.71, still down 1.5 percent on the year and short of its all-time high.

After a dramatic year for the markets in 2013, in which the indices ranked within the top 15 percent of all time returns, the markets took a breather in January 2014. This was not unexpected after the 2013 run-up. But what was not clear was what direction would follow.

With powerful snow and ice storms walloping the East Coast, a rerating of profit expectations, and turmoil in Europe, the Middle East and Asia, the factor of risk came to the forefront. As fourth quarter earnings reports were announced, profits were better than expected, but not strong enough to raise valuations. Revenue growth disappointed and forward guidance was muted. With price earnings ratios at 15.1 times next years’ earnings, the P/E level is above the 13.9 percent average rate of the 10 years.

International events in China, Ukraine and the Middle East did nothing to calm fears. Even the euphoria of the Olympics was transitory. Not surprisingly, investors paused.

But, with fourth quarter earnings up 9.6 percent from a year ago, the market resumed its upward trend – a nice recovery from 2007, when fear abounded. The market tends to (but not always) look to the future. It tends to look six to nine months out; so with the economy in a slow recovery, investors are liking what they see.

Investors are also restricted in their investment options. Fixed income returns paltry sums. Indeed in 2013, fixed income returns were in the lowest 97 percent of all-time returns, losing money in some cases, even before the effects of inflation. For the most part, markets in other countries did not do as well as the U.S.

Other asset classes did not do well either. Gold plunged 28.9 percent, real estate was up 2.5 percent in 2013 as measured by the NAREIT index under performing the broad market by a wide margin, and alternative investments under performed. Even Warren Buffett, who could be considered to be an asset class by himself, under performed the market for the fifth straight year.

Since money goes where it is treated best, it was not surprising that equity markets did so well, and that they continue to do well, because there is seemingly no end in sight to our current situation.

However, the Congressional Budget Office declares that we should not consider the slow growth of recent years unusual. We should get used to it. The CBO believes that Americans will earn less than they expected previously, keeping in mind that personal income, allowing for inflation, is down 6.1 percent since the peak in 2007.

Further, according to the CBO, fewer Americans will want jobs, since they no longer need to work to get medical insurance. Even fewer will get jobs. They think that companies will invest less and earn less. They believe the economy will settle into a prolonged period in which the economy grows at a rate of 2.1 percent.

Job growth will average less than 70,000 per month. Since the economy needs to create 250,000 jobs per month just to accommodate new job seekers, this is a bleak job forecast indeed. Americans further believe that the economy will grow at a slower rate than any comparable period since the Great Depression. Also, when interest rates rise, as forecast, the federal government will have to pay increasing amounts of interest just to service existing debt.

Which is right: the CBO, or the markets? Could they both be right? I am betting on the market.