What is ahead for 2014? - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 2 January 2014
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So what's ahead for 2014? We don't know...but we know that what most people think they know is not so. Most people think 2014 will be a 'return to normal.' Don't count on it.

Whatever happens, it will be hard for the stock market to match 2013. During the last 12 months, the S&P 500 gained an astounding $3.7 trillion.

To put this in perspective, the S&P lost 1% per year from 2000 to 2009. Then, with the Fed's jet engine behind it, stocks took off...bringing the total return to 3.6% per year. Still not great. But a lot better.

But what does it mean when stocks gain $3.7 trillion in a single year? The underlying companies couldn't possibly have changed in any fundamental way. Most likely, they are the same now as they were at the beginning of the year -- run by the same people, doing the same business, making the same sales. So, why are they worth so much more?

Profits are higher -- largely because the Fed's zero rates made it possible to borrow cheaply. The companies used the cheap credit to

  1. buy new capital equipment, thus replacing expensive labor with machines and electronics
  2. refinance expensive debt, lowering interest charges
  3. buy back their own shares, raising their share prices
It's not likely that they will be able to repeat the trick in 2014. Because interest rates are moving up.

The Financial Times announced the big news at the end of last week. Yield on 10-year Treasuries Reaches Above 3%, was the top headline (or words to that effect). It was big news because the cost of money affects all financial transactions. When interest rates rise you have to begin looking in drawers and under seat covers: Where were those questions we used to ask?

The Aam Investor Asks... And Answers!

Equitymaster Club - The Aam Investor Community, is already buzzing with activity...Hundreds have registered, and many of them have already started to interact with fellow Aam Investors...

What are the Aam Investors discussing? Well, here are the most popular questions...

»  How important is management quality while investing in stocks?
»  Which are the books worthy of read that debunk the myths in investing?
»  Can I extend PPF account after maturity?
»  Which are the best books written on successful investment strategies?

Go ahead, and join in these discussions! Or see what's the latest in the Equitymaster Club!

How will debtors be able to keep up with interest charges...now that refinancing means making higher payments? How will homeowners pay their mortgages?

If you can earn 3% on 'risk-free' Treasuries...does it make sense to buy ex-pensive stocks? Real estate? Andy Warhol's doodles?

Will any investment do better than 3%? Is the extra risk worth the extra re-ward?

Those are questions corporate treasurers and investors barely needed to ask at all a few months ago. When the 10-year yield hit its low of 1.6%...it put the 'risk free' yield below the consumer price index at the time. This meant that any investment with a positive yield -- no matter how small -- was a good one. The hurtle was so low even a snake could slither over it. Bad investments? Stupid spending? Incompetent managers? It hardly mattered; money was essentially free.

Now in 2014, nominal yields are twice as high and the CPI is sinking; the real yield has gone from around zero to around 2%. And that brings back the question marks. But the main question is this: are rates headed back to "normal" levels? And what will happen if they rise more?

Since WWII the average yield on 10-year notes was about 5.9%. Headed back to that 'normal' level...from today's abnormally low levels...would not bring a 'normal' financial world. It would bring a disaster.

At 'normal' yields, it would cost the federal government $440 billion more in finance costs. That would push the deficit back over $1 trillion...and it would set off a chain reaction of bad news both in the private sector and in government.

Yes dear reader, the US economy depends on cheap credit . When credit gets to be more expensive millions of retirement plans, investments, and budgets get busted. In fact, they will be almost all busted. Stocks will go down -- probably crashing down to about half their values today. That $3.7 trillion they gained this year will disappear...and then some!

Well...easy come, easy go.

But normal? Far from it...

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

Disclaimer:
The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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