Five years have passed since the bull run in the S&P 500 began. One of the major reasons for the rally is the U.S. Federal Reserve's "quantitative easing" program, which began in November 2008 and is ongoing. Since March 2009, the S&P 500 has gained about 170%. But can it continue the upward trajectory seen in the last five years?
What could keep the rally going?
QE3 -- the Fed's most recent round of long-term asset purchasing -- is expected to end this year, as the central bank has already begun drawing down, or "tapering," its bond purchases. Last Friday's nonfarm payrolls data, which came in better than expected, has ended speculation that the Fed will slow down the pace of tapering. We'll find out more on March 19, when the Federal Open Market Committee, the Fed's policy-setting body, concludes its next two-day meeting.
But Fed tapering has not had the sort of negative impact market participants were expecting. After a weak start to 2014, stocks stabilized, with the S&P 500 gaining more than 3.7% since the start of February. As I noted in a previous article, the stock market is returning to normal as the Fed withdraws its support. Going forward, fundamental factors such as earnings growth, share buybacks, and a rise in mergers and acquisitions will drive the market upward.
The market was driven by P/E multiples during the Fed-fueled rally, but actual earnings growth will drive the market from here. For the first quarter of 2014, FactSet forecasts earnings growth rate of 0.5%, down from an estimate of 4.4% at the beginning of the year. The extremely cold weather in the U.S. seems to have affected companies' performance in the first quarter. However, FactSet expects earnings to grow 7.7% in the second quarter and 11.1% in both the third and fourth quarters. That adds up to an impressive forecast of 8.8% growth in earnings across 2014.
Indeed, earnings growth rates could accelerate as the year goes on, as several companies are expected to boost capital expenditures, especially in sectors that stand to benefit from the U.S. economic recovery, such as industrials. One such company is United Technologies (RTX 0.41%). In January, the company said its capital expenditures in 2014 would be around $2 billion -- an increase of 18% from 2013. The company also expects robust earnings growth in 2014, with earnings per share between $6.55 and $6.85 compared with $6.21 per share in 2013.
Companies are more confident about the economic recovery and are willing to boost capital spending. This, in turn, will drive earnings growth in 2014 and beyond.
Another key driver of upward momentum will be share buybacks. Low interest rates and robust cash position led to an increase in share buybacks in 2013. According to S&P Dow Jones Indices, buybacks rose 15% to $445.3 billion for the 12-month period ended Sept. 30, 2013. This trend could continue, as several companies have shown commitment to returning cash to shareholders via buybacks and dividends. Even though United Technologies expects to invest $2 billion in the business, it remains committed to share repurchases, planning to buy back $1 billion worth of shares in 2014.
Growing shareholder activism has also prompted companies to increase buybacks. Apple (AAPL 0.81%) bought back $14 billion worth of stock in February. The company has been under pressure from Carl Icahn to use its huge cash reserves to buy back more shares. Last week, Apple announced that its CFO, Peter Oppenheimer, will retire at the end of September. His position will be taken by Luca Maestri, the current vice president of finance and corporate controller. Maestri's appointment has raised hopes of more share buybacks, as he is seen as someone who favors boosting shareholder returns. Maestri gets this reputation from his past stint as Xerox CFO. During his tenure, Xerox's share repurchases rose from zero in 2010 to $1.1 billion in 2012, according to The Wall Street Journal. .
Rise in M&A activity
An increase in M&A activity is also expected to drive the market this year. On Monday, Chiquita Brands (NYSE: CQB) announced that it will merge with Fyffes, creating the world's biggest supplier of bananas. The stock-for-stock transaction will see shareholders of Chiquita Brands owning approximately 50.7% of the combined company. The combined company will be able to expand its geographic footprint and distribution channels, which will enable it to access new market opportunities. The Chiquita-Fyffes deal is the latest in a series of M&As announced this year. According to global accounting firm KPMG, M&A activity is expected to be strong in 2014. A survey conducted by the accounting firm of 1,000 M&A professionals, investors, and advisors showed that 63% expect their U.S. corporate clients to initiate at least one acquisition in 2014.
After the Fed-fueled rally of 2013, fundamental factors suggest that the upward momentum could continue in 2014. While the gains won't be anywhere near those seen in 2013, investors can expect steady returns in 2014.