What's Going On?

Investors were spoiled by the 2013 action and are now asking why the robust rally has not continued into 2014. Does this mean we are topping or in the midst of a correction? Or are all systems go among a bit of volatility? Here is the view from my perch:

1. The S&P 500 was up 2.2% in the quarter. That annualizes to around 9%, so we are actually on pace for an average year.

2. As ISI notes in this table circulated by Raymond James strategist Jeff Saut, most financial measures are a bit better now than at the start of the year, most notably interest rates being a touch lower.

3. The path of least resistance for oil is down, with the shale revolution in the U.S. Saut notes, "Commercial traders think crude oil is going to decline, having built their largest net short position of all-time."

4. Money conditions are actually loosening, despite talk of the Fed tightening on the margin. First Trust's Brian Wesbury notes that "commercial and industrial loans have grown at a 23% annualized rate in the past two months, while the M2 money supply has jumped to a 9% growth rate."

This would argue for a better economy on the margin, especially as we bounce back from weather-related sluggishness in the first quarter, which should be better for earnings and thus stock prices.

The fly in the ointment, however, is that very trend in earnings. The primary investment thesis that has served me so well in 20 years of managing money is that stock prices react to changes in expectations so that you need improving prospects to drive prices higher from whatever is their current level. Unfortunately, for the past year the prospective S&P 500 earnings are getting worse not better. All throughout 2013, analysts cut their estimates for S&P 500 operating earnings in 2014 -- in fact, they are now 5% below the estimate a year ago, even with the index price up by a third.

I argue relentlessly (and incorrectly in 2013) that this gap cannot persist. Either stocks need to take a breather or decline, or earnings need to start accelerating. I am waiting patiently for the acceleration. If economic conditions are as good as advertised, why aren't analysts raising their expectations for 2014? This is a mystery that leaves me positioned very cautiously. I am not willing to short the market -- that could have put me out of business in 2013 -- but I want to carry a lot of cash and focus my holdings on names with the best estimate revisions upward.

As they say, be careful out there. I will be, as I continue my on-the-ground research in India at Ranthambore National Park. The prospect of being eaten alive on a tiger safari is even more daunting than having our stock market eat you alive.

At the time of publication, Dvorchak had no positions in any stocks mentioned.