Is the stock market getting too overheated?

Just a year ago, as the ball dropped in Times Square New Year's Eve, the U.S. government was dropping a ball of its own: The responsibility to keep us from going over the "fiscal cliff," when spending cuts and tax increases were set to kick in. But by day's end, on January 1, 2013, Congress had cobbled together a last-minute deal, avoiding the global "economic Armageddon" that was likely if our country had actually defaulted on its debt.

From the perspective of 2014, the fiscal cliff hysteria and fears of eroding the implied rock-solid "full faith and credit" repayment of all U.S. debt obligations will be just another of the apocalyptic predictions that seem overwrought in hindsight — much like the "Y2K" fears in 2000 that coding the "year field" as the two-digit 00 could potentially cause worldwide, systemic computer failure if computers rolled over to the year 1900 instead.

Traders on the floor of the New York Stock Exchange.
Getty Images
Traders on the floor of the New York Stock Exchange.

Understandably, many play it close to the vest during such uncertain times. Investor convictions were repeatedly tested during 2008 to 2012, with ongoing dysfunction in Washington, a sub-prime-induced meltdown of our banking system, and Europe's rapidly deteriorating economic situation. All this uncertainty was amped up when 2013 began with the Congressional bungee jump off the fiscal cliff and back.

That is why a year ago I felt compelled to write "Four Reasons to be Optimistic" to point out why my outlook for the markets, based on my homework and view of emerging trends, was optimistic. I highlighted four principal reasons: corporations were still sitting on a lot of warehoused capital; the housing market was beginning to look better; new sources of energy (principally fracking) were emerging; and the euro zone was beginning to stabilize.

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And, in fact, 2013 was a stellar year — despite the cumulative fiscal drag of a 16-day government shutdown, the budget cuts mandated by sequestration, a 2-percent reduction in take-home pay due to the end of the Social Security tax break, the tax hikes mandated by the Affordable Care Act, and unease about whether and when the Federal Reserve would begin to taper off quantitative easing (QE), the massive money-printing program meant to stimulate an economy enduring such shocks to its system. A mere hint from Ben Bernanke that QE might be ending caused world markets to retreat in May, but in December, when the Fed officially announced tapering was actually going to begin, the market actually staged an impressive rally.

Many signs indicate that the economy is indeed recovering and fears of a recession are, at the moment, unfounded. In fact, the major reason that I am once again optimistic about the year ahead is that I believe this message will seep into the collective market psyche and be increasingly reflected in equity valuations.

When financial historians analyze investor returns subsequent to the 2008 market upheaval, I think what will really stand out is how significantly the returns achieved by those who looked past the headlines outpaced the returns of people who didn't. Paralyzed by fear, the latter kept a disproportional amount of cash in the bank or invested in very low-yielding bonds and failed to participate in the market rally which had begun in 2009 and kicked into hyper-drive in 2013.

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Given last year's very strong performance, the next big question is inevitable: Is the market overheated and ready for a fall? I say probably not. Though I don't believe 2014 will deliver equally huge returns, I continue to be optimistic not only for the reasons I have already stated but also other positive developments:

  • The emergence of both the euro zone (a quarter of the world's economy) and Japan (the world's third-largest economy) from protracted recessions will continue to have positive effects for markets around the world.
  • Now that a budget deal has been reached, market-spooking rumors are unlikely to emanate from Washington. I do not believe either party, anticipating the November mid-term elections, will have an appetite to fight about the debt ceiling in February.
  • With the Fed signaling "lower rates for longer," companies that have been stockpiling cash will likely start deploying greater amounts of their reserves for long overdue capital improvements and expansion investments rather than have them continue to remain idle, earning next to nothing, for an increasingly protracted period of time.
  • Fearful investors with bunkers full of cash and over-allocations to bonds continue to be held hostage to ultra-low interest rates and the anticipation of the losses that will accompany the inevitable rate hikes. High-quality equities remain one of the few reasonable alternatives when the great rotation occurs.
  • A recovering housing market is likely to send a wealth effect rippling through the economy. The housing market is continuing to transition from purchasers who are investors and speculators to those who intend to occupy the homes they buy.

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Certainly, some events can derail the market in 2014 — for example, corporate earnings falling short of expectations or unexpected geo-political news from the Middle East. Still, I believe the bias is to the upside, and the greater "risk" remains being out of a rising market rather than being caught in an overheated crashing market. While stocks are not the relative bargains they have been in recent years and interim market corrections are to be expected, the current situation doesn't feel like a market top to me. Market tops are usually associated with excessive speculation and irrational investor exuberance, neither of which characterizes the present market.

— By Ken Kamen

Kenneth A. Kamen is a managing director of The Mercadien Group and president of Mercadien Asset Management and Mercadien Securities, as well as the author of the book,"Reclaim Your Nest Egg: Take Control of your Financial Future."