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What Keeps Me Awake Now

I still believe we will emerge from the slow growth in productivity. Nevertheless, it's crimping corporate profits.

In early 2011, I wrote a column titled “What Keeps Me Awake,” in which I outlined unfavorable events that could derail my bullish outlook for stocks. Now that the Dow Jones industrial average is more than 3,000 points higher, it’s time to revisit that question.

In 2011, fear of another debt crisis was a major concern for investors. The Lehman Brothers bankruptcy was still fresh in their minds, analyst Meredith Whitney was predicting a municipal bond collapse, and the European debt crisis was heating up. Just six months later, Standard & Poor’s downgraded the credit rating of the U.S., another move that shocked investors.

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Fortunately, we have largely navigated through those troubled waters. With households and businesses paying down their debts, and prices for stocks and real estate on the rise, an imminent debt crisis is now unlikely. Despite Detroit’s bankruptcy, no other locality of that size has failed to pay its obligations.

The European debt situation has also improved substantially. And even though the ongoing European recession has been long and deep, there are some signs of recovery. Even the U.S. budget deficit has shown remarkable improvement, with the deficit for the fiscal year that ends September 30 projected to be $642 billion, down more than 50% from $1.3 trillion in fiscal 2011.

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Nevertheless, there are real deficit problems down the road as retirement demands on Social Security and, especially, Medicare soar. But those problems will not affect today’s bull market.

Inflation trends. With the Federal Reserve and other central banks flooding the world with money, many people are concerned that inflation will threaten the U.S. economy. But the Federal Reserve can reduce its balance sheet and absorb the excess reserves it has created by requiring banks to hold higher reserves. I do think that inflation will trend a bit higher than the Fed’s official 2% target, but inflation in the range of 2% to 4% has not been bad for the stock market in the past.

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One risk I did not note earlier was the country’s poor growth in productivity, which measures the output of the economy per hour worked and determines the standard of living. Productivity growth averaged only 0.6% in 2011 and 0.7% in 2012, with the first half of 2013 not much better. That’s considerably below the 2% average the economy has recorded since 1970.

The fall in U.S. educational achievement could be one cause, as well as the long periods of unemployment many Americans have experienced as a result of the recession. I still believe we will emerge from the slow growth in productivity. Nevertheless, it’s crimping corporate profits.

Two additional risks could strike the market at any time. I still worry about a terrorist attack, especially one involving nuclear material. A nuclear strike would be catastrophic not only because of the lives lost but also because of the costly security measures needed to prevent another one.

To terrorism I would add a new concern: a pandemic caused by a pathogen we cannot contain. We have had a number of fleeting epidemics in recent years, and even when the threat is not high, behavior can change radically. Yum Brands, which owns Kentucky Fried Chicken, says that fears of bird flu kept Chinese away from its restaurants in droves earlier this year, even though the disease could not be transmitted through cooked chicken.

I am hopeful that anti-terrorist surveillance as well as the creation of vaccines will mitigate these risks. They may temporarily deflect us from our upward path, but they will not change my forecast of increasing economic growth and higher stock prices.

Columnist Jeremy J. Siegel is a professor at the University of Pennsylvania’s Wharton School and the author of Stocks for the Long Run and The Future for Investors.

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