Nothing grabs investors’ attention than a prediction of a stock market crash, whether it comes from a famous investor or a not-so-famous writer.
Think back to how many times this year you’ve read or heard someone predict a market crash or major correction so far in 2014. And why not? Nail this prediction, and you become the next Elaine Garzarelli, who made her name by accurately calling the 1987 crash.
But there’s one glaring problem with paying too much attention to all this market crash talk:
The most important driver of this bull market — the lack of compelling alternative investments to equities — is firmly in place.
And it’s going to stay that way for at least another year.
ZIRP Keeps the Spotlight on Stocks
This isn’t exactly news. Anyone with skin in the game knows that the zero-interest-rate policy of the U.S. Federal Reserve has taken a huge swath of potential investments off the table for any purpose other than safety of principal.
Bank products, money market funds, savings bonds and short-term bond funds all still serve the needs of conservative investors who need to keep their money safe, but otherwise, they are of little use to anyone who needs to build up cash for the future.
This is one reason why the stock market has only suffered shallow downturns in recent years: As soon as stocks suffer a modest dip, money flows in from the sidelines to drive prices right back up again.
With so much cash needing to be put to work, few investors are waiting for a double-digit correction to boost their allocations to equities.
And this phenomenon might become even stronger as 2014 progresses.
On Tuesday, CNBC reported that global investors have boosted their cash holdings to a two-year high, with managers now holding 5% of their portfolios in cash.
The previous high occurred in June 2012. Not coincidentally, the S&P 500 rose nearly 6% in the second half of 2012, while the Russell 2000 gained 7.2%.
The one-year returns: 20.5% for the S&P, 24.2% for the Russell 2000.
Sound like a stock market crash to you?
Fed Policy Is Unlikely to Change Anytime Soon
The most important consideration is that this environment isn’t going to change in the near future. The Fed has said that it will wait at least six months following the end of quantitative easing before it begins to raise interest rates, which means that there is at least another year before rates begin to tick up. Once they do, the Fed is likely to take a gradualist approach, especially without the spectre of inflation to cause it to speed up the pace of rate increases.
And even a mid-2015 hike isn’t a guarantee — if economic growth remains as sluggish as it was in the first quarter of the year, the Fed might extend its timeline even further.
Still, let’s say for the sake of argument that the fed funds futures markets — which can be viewed here — are dead on. If that’s the case, investors still would be looking at short-term rates of 0.75% as late as October 2015, which still would imply a negative real (after inflation) return on safe investments.
A move in real yields on money market funds from -1.5% to -0.75% is hardly the fuel to spark a rotation out of equities — especially if large-cap stocks are still yielding in the mid-2% range at that time.
In short, the stock market looks to be the best game in town for a long time to come.
It’s unlikely that a stock market crash, or even a major correction, will occur of its own accord. For the Marc Faber/Nouriel Roubini crowd to be correct in their market crash calls, an unforeseen external event will need to drive the market lower.
That can happen at any time, of course. But without this type of negative surprise, the lack of alternatives to equities continues to be the main support for the bull market — just as it has been for the past five-plus years.
For now, buying the dips remains the order of the day.