There is no better propellant for a market than low expectations. The S&P 500 has gained roughly 3.5 percent during this earnings season as expectations recalibrated with reality.

According to Factset, the S&P 500 collectively will earn .2 percent less than they did a year ago, versus pre-earnings season expectations of a 1.5 percent decline. So, don’t confuse this rally in sentiment with a rally in fundamentals.

That will come later in the year … or so it is expected.

It’s All About the Rates

In a no-growth earnings environment, the value of the market becomes a simple calibration of earnings yield with bond yields.

The market currently trades at 17 times trailing earnings. A 17 P/E ratio is the equivalent of to a 5.88 percent earnings yield.

The Baa corporate bond yield, a decent proxy for comparison, is 4.85 percent. Which would you prefer: 5.88 percent or 4.85 percent? If you chose 5.88 percent, you win! Buy stocks.

In early December of 2013, the Baa bond yield was 5.5 percent, nearly a full percentage point higher than today. With rates and multiples inversely correlated, this decline in rates actually supports higher P/E multiples.

Therefore, even as earnings languish, the earnings themselves become more valuable as interest rates fall. So the market has resilience at these levels as long as rates remain anchored.

Potential Rate Raisers

The Fed’s favored consumer price index notes a current inflation rate of 1.1 percent. Since the Fed’s inflation target equals 2 percent, this implies little risk of Fed-induced rate increases. That is unless supply shortages begin to softly nudge inflation components higher.

For instance, due to malevolent weather, the Dow Jones Commodity Index has gained 10 percent so far this year.

While these items tend to be excluded from the Fed’s point-in-time inflation numbers, they do gradually work their way through to other components. More directly, total employment costs appear subdued, but annual wages have actually risen 3 percent.

Employers have offset these wage increases by trimming benefits, but that can’t last forever. If wage and commodity pressures persist, we could receive a surprisingly strong inflation report sometime this year.

Economists expect that first quarter GDP grew at a sub-2 percent pace as the extreme weather conditions froze US consumer activity.

However, with job gains building and Washington quiet, consumer confidence has now risen to cycle highs. Higher confidence, rising wages, and pent-up demand may set the stage for a surprisingly strong second-quarter GDP growth figure.

Economists expect 3 percent growth in the second quarter. A number higher than that might invite Fed attention and market anxiety.

Bottom Line

With earnings growth meager, the movement in multiples will determine the fate of the stock market in 2014. With multiples inversely correlated with interest rates, stock market investors should be on rate watch. Year to date, low rates reflect low inflation and low growth.

However, beneath the surface some inflationary stimulants are percolating. Expect interest rate uncertainty to increase and stock market volatility to follow as the year progresses.

David Waddell, who is regularly featured in the Wall Street Journal, USA Today and Forbes, as well as on Fox Business News and CNBC, is president and CEO of Memphis-based Waddell & Associates.