Stock Market’s Dependence On Easy Money Weakening?

There’s a significant cold spell out there in the Mid-East and Northeastern parts of the country. At the same time, the stock market has cooled down a little, beginning the year on a cautious note.

I recently discussed my views for the stock market going forward and while it’s early on, the ability to move higher will largely depend on the economic renewal and its impact on what the Federal Reserve does. New Fed Chair Janet Yellen will be the focal point as Ben Bernanke departs.

Yellen will receive her first piece of key economic data this Friday when the non-farm jobs report for December is due. A decline in the unemployment rate to below seven percent and the creation of 200,000-plus jobs will clearly drive the Fed to seriously continue to taper. What happens to the stock market this year will be dictated by the rate of jobs growth and the number of unemployed.

We also need to see corporate America deliver stronger revenue growth to drive earnings. In the past few years, aggressive cost cuts have driven earnings, which is not sustainable.

If the tapering continues, bond yields will continue to rise to levels that will be difficult for stock market investors to ignore. Look for an initial break at the three-percent level for the 10-year bond to gauge its impact on the stock market.

Should yields rise, I would look at the higher dividend paying stocks, especially those in the small-cap sector that offer great opportunities for dividends and capital appreciation.

The reality is that, given that the stock market was able to rise as much as it did in the past year, the upside moves will likely be more limited and not at the same pace.

Also keep in mind that the stock market has yet to have a major stock correction, which I define as 10% or more, since this current bull market began in March 2009. Into the fifth year of the bull market and looking at the longer-term charts, I still feel the S&P 500 is vulnerable to a stock market correction that could be in excess of the seven-percent maximum we have seen.

But what makes me confident is that a major stock market correction would open up buying opportunities for traders and investors.  It may be this expectation that helps to limit any strong upside advances, at least early on in the year.

The key is to look for opportunities and to look at what I call “chaos” as a buying opportunity.

Be careful with the housing sector, as much of the easy money has been made in this area. The housing market is much stronger than it was in 2008, but you should expect some stalling as mortgage rates begin to rise. I would look at the home supplies companies as an alternative, such as The Home Depot, Inc. (NYSE/HD) in the large-cap area and Builders FirstSource, Inc. (NASDAQ/BLDR) in the small-cap segment.

Should the economy continue to improve, watch for small-cap stocks to advance, but don’t expect them to rise at the same pace as 2013, when the Russell 2000 led the broader stock market with a gain in excess of 30%. Small companies tend to have the flexibility to more easily adapt to changes, so this group should be a key area to monitor this year.

Overall, I remain optimistic that the performance of the stock market will largely be dependent on the fundamentals and less on the flow of easy money into the economy.

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Courtesy of George Leong, B. Comm.

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