I didn’t know much when I started at Briefing.com in 1997, but I know more now having studied at the desk of on-the-job experience. It has been some tough and informative learning, too. I have worked through the inflation and the popping of the dot-com bubble, the Asian currency crisis, Long-Term Capital Management, 9/11, the war on terror, the inflation and popping of the housing bubble, the financial crisis of 2008, a literal crash in stock prices, the Great Recession, the eurozone debt crisis, the implementation of quantitative easing, the debt ceiling debacle, and one of the best bull markets on record.

I hesitate to say it, but normalcy isn’t a word that comes to mind when I think of my professional experience, unless of course one accepts that it is normal for the world – and the capital markets by extension -- to be a crazy place.

With that in mind, I’m seeing some craziness again within the stock market. Momentum investing has pushed a number of stocks to ridiculous valuation extremes, so much so that non-traditional valuation metrics, like the price-per user ratio for social media stocks, are being used to validate nosebleed stock prices. In turn, NYSE margin debt is at a record high as investors have used leverage in an effort to enhance returns in an environment of low rates and relatively low volatility. The potential for earnings has superseded actual earnings as a catalyst for investment in certain areas; and there is a general sense of complacency that nothing bad will happen.

These conditions are reminiscent of the conditions during the dot-com bubble. A key difference between now and then, however, is that the broader market has not hit bubble valuations – only certain industry groups and certain stocks have. Not surprisingly, we have seen many of them correct sharply in price already. That correction has led to a renewed appreciation for value investing that has been grounded in companies with balance sheet strength, earnings dependability, and free cash flow that is being deployed for dividend payments and share buybacks.

Other trends I see include an increase in IPOs and M&A activity, both of which are byproducts of a long-running bull market.

The answer frankly lies in the money supply. The problem isn't that there is too little money. The problem is that there is too much money doing nothing or at least very little.

The bid to sustain 3.0%+ GDP growth is being foiled by a factor that has undercut the economy's growth potential since the recession ended. Specifically, money isn't turning over with animal spirits in anything other than the stock market.



(Note: The ratio for the velocity of money is derived by taking quarterly nominal GDP and dividing it by the quarterly average of M2 money stock.)

The money supply is there for the taking, but the take on that dole is lacking since the expansion of bank loans and leases has been weak, potential borrowers aren't pining for the credit, and corporations aren't spending their cash with demand-driven conviction.



There is a whole lot of pent-up growth potential in the money supply, but until money starts turning over with more velocity, neither the US economy nor inflation will take off as many thought they might with the Fed's embrace of quantitative easing five years ago.

The future is inherently uncertain, yet lending, borrowing, and spending behavior today imply confidence in the outlook is still lacking -- and confidence is key in changing the impact of the vast supply of money that can be deployed to help the economy achieve escape velocity.

My expectation at the end of 2013 was that stock market return will be positive -- but modest -- in 2014. That view was predicated on the following factors:

• The S&P 500 increased 30% in 2013 on EPS growth of just 5%, leading me to think that the market pulled forward 2014 returns into 2013.
  
  
• The fear entering 2013 that so much could go wrong was supplanted by a sense that everything will now go right. In other words, there is not as much room to climb the proverbial wall of worry.
  
  
• Current P/E multiples reflect record profit margins that will be more challenging to sustain.
  
  
• Volatility will increase as the market transitions from the old normal of more quantitative easing to the new normal of less quantitative easing.
  
  
• Since 1929 the average price return for the S&P 500 in the third year following a gain of 10% or more in each of the previous two years has been
  -1.25%. For the seven instances since 1929 in which there has been a third consecutive "up" year, the average gain has been 10.9%.

The fundamental factors underpinning my practical view of the 2014 stock market outlook are still in place. Here's what I also said at the end of 2013:

• Earnings growth, now projected to be 11%, will probably be revised lower but still remain positive (it has come down to 7.8%)
  
  
• Real GDP growth should be about 2.5% (probably closer to 2.0% now taking into account the weak Q1 GDP report)
  
  
• Overall CPI will stay below 2.0% (it is now 1.5%)
  
  
• Long-term interest rates will press higher gradually, but not sky past 3.50% (10-yr yield currently at 2.68%)

An expected return of 6-7%, which takes into account a dividend yield of 2.0%, remains a reasonable forecast for 2014 and is fairly consistent with the average return of 7.1% since 1929.

The road to such a return could be bumpy. Check that. It has been bumpy so far in 2014.

The near-term risk-reward dynamic doesn't look that attractive right now, so some greater defensive posturing is perhaps in order.

We're not enamored with the rising use of margin debt and the speculative excess taking place in certain parts of the stock market; we are unsettled by the shadow banking risk in China; geopolitical risk is elevated; the Fed is toying with its guidance; and we're not convinced the economic slowdown in the first quarter was just weather related.

Things will undoubtedly change and the manner in which things change to influence the earnings outlook will affect our stock market outlook.

At this juncture, there is still a fundamental basis in the earnings, interest rate, and inflation components to think the stock market will be able to deliver another positive year in 2014. Risk management, though, should not go unappreciated along the way.