What will 2014 bring?

At the end of every year there are always lots of guesses of what the next year in the markets will bring.  If you guess right in the media you can get lots of accolades while guessing wrong pretty much gets forgotten.  So far I have mostly seen reasons why stocks will go up in 2014.  I thought this quote was interesting from the Calculated Risk blog.

For the last few years, "downside risks" were fairly high on my list of "questions" for the coming year. Europe has been an ongoing risk, and last year my top question was related to fiscal policy and the risks associated with the House of Representatives (with dumb policies like not cutting back on sequestration, and dumb stunts like shutting down the government).

Happily, looking forward, it seems the downside risks have diminished significantly. China remains a key risk with growth slowing and significant uncertainty around the large number of poor performing loans. That might be the #1 downside risk for 2014, although China remains opaque to outside observers - and the downside risks to the U.S. are probably small.

...
When I look around, I see few obvious downside risks for the U.S. economy in 2014.   No need to borrow trouble - diminished downside risks are a reason for cheer. 

I think this is a pretty prevalent feeling that there is now much less to worry about then the last few years.  The wall of worry has been dismantled and there is nothing but blue skies up ahead for the market.

That is one end of the spectrum, but there is still a crowd on the other side as this analyst from Saxo.


The US economy is stabilizing, but it's not truly recovering. That's the view of Saxo Bank's Chief Investment Officer, Steen Jakobsen. Following the Fed's tapering news, Steen says the risk is that we trade on perception and not reality. Clearly, the outgoing Fed Chairman, Ben Bernanke, wanted to send a signal to the markets.
Global equity markets, notably in the States, have been hitting record highs for weeks; but Steen warns "we're coming to the end of that cycle." Actual growth in America is well below the average rate of the past 60 years and job creation too is lagging. People may be starting to feel more confident but that's still not translating into significantly higher employment or wages.  
"We're at the end of asset inflation," he says, and that "will dawn on the market very soon."


There are some valuation measures besides P/E that show the market very over valued.  It is hard to argue that the Russell2000 with a P/E around 80 is not a bubble.   Will 2014 continue to find greater fools to bid up the prices of small cap stocks?

What does history say about what could happen in 2014.  Most 20%+ years in stocks have been followed by more gains the next year.   Sometimes big gains.  A few have been followed by losing years.  Statistics say odds should be for higher prices.  However, there are two possible historical problems.  The second year of the presidential term is statistically the worst for the markets with the party in power not making much difference.  Some very big sell offs (does 1987 ring a bell) have happened in that year with Sept. being the most likely time to bottom.  The other potential historical problem is one I have mentioned on the blog before.  The only other time the market gapped up on the first trading day of the year and never looked back two years in a row was in 1975-76.  Those two years were followed by a down 1977 where the market did not bottom until 1978.

There is a lot of excitement about the U.S. economy these days.  So if the economy is really that strong then why are corporations issuing negative-positive surprises at the highest rate since the data has been tracked.  This quarter surpassed the previous peak in 2001 which was right before a recession started.  The GDP is the most unreliable data the government issues.  It has seen huge revisions sometimes years later.  Another unreliable piece of data is the employment numbers.  Those numbers are also subject to big revisions.  These two items seem to be what has so many so positive on the economy.  They have proved to be unreliable in real time though.  There are other pieces of data that paint a somewhat different picture.  Check out this chart.

Source

When you look at the year over year change of personal consumption expenditures it looks like we are close to a recession.  This chart goes back to the 40s and the data has never been this weak without being in or near a recession.  There are still questions in my mind on the true strength of the economy.

So what will it be in 2014?  Regardless of whether we end the year up or down I believe we will see a bigger pullback then we saw last year.  It seems likely to me that some time in Jan. the market will peak and there will be some significant profit taking as people lock in gains from the last two years.

If there is trouble for stocks next year it is likely to come from outside the U.S.  Global economic growth has been slowing since 2011.  There are signs of stress in many emerging markets including China.  Those signs of stress have been mostly contained in their bond and currency markets.  Historically that is often where trouble starts before eventually affecting stocks.  Whether anything truly bad happens there remains to be seen.  The risk is real, but hard to quantify.

I am lucky if I can predict what is going to happen tomorrow or the next few days in the market.  I am not going to try and predict what is likely to happen over a full year.  However, I think there is a considerable risk of higher interest rates, slower economic growth then expected and not so hot corporate profits.  Any of which could hamper stock prices.   

Bob

Happily, looking forward, it seems the downside risks have diminished significantly. China remains a key risk with growth slowing and significant uncertainty around the large number of poor performing loans. That might be the #1 downside risk for 2014, although China remains opaque to outside observers - and the downside risks to the U.S. are probably small.
Read more at http://www.calculatedriskblog.com/#DuacR3cuZqT7jBP2.99

For the last few years, "downside risks" were fairly high on my list of "questions" for the coming year. Europe has been an ongoing risk, and last year my top question was related to fiscal policy and the risks associated with the House of Representatives (with dumb policies like not cutting back on sequestration, and dumb stunts like shutting down the government).
Read more at http://www.calculatedriskblog.com/#DuacR3cuZqT7jBP2.99

For the last few years, "downside risks" were fairly high on my list of "questions" for the coming year. Europe has been an ongoing risk, and last year my top question was related to fiscal policy and the risks associated with the House of Representatives (with dumb policies like not cutting back on sequestration, and dumb stunts like shutting down the government).
Read more at http://www.calculatedriskblog.com/#DuacR3cuZqT7jBP2.99

For the last few years, "downside risks" were fairly high on my list of "questions" for the coming year. Europe has been an ongoing risk, and last year my top question was related to fiscal policy and the risks associated with the House of Representatives (with dumb policies like not cutting back on sequestration, and dumb stunts like shutting down the government).
Read more at http://www.calculatedriskblog.com/#DuacR3cuZqT7jBP2.99

For the last few years, "downside risks" were fairly high on my list of "questions" for the coming year. Europe has been an ongoing risk, and last year my top question was related to fiscal policy and the risks associated with the House of Representatives (with dumb policies like not cutting back on sequestration, and dumb stunts like shutting down the government).

Read more at http://www.calculatedriskblog.com/#DuacR3cuZqT7jBP2.99

For the last few years, "downside risks" were fairly high on my list of "questions" for the coming year. Europe has been an ongoing risk, and last year my top question was related to fiscal policy and the risks associated with the House of Representatives (with dumb policies like not cutting back on sequestration, and dumb stunts like shutting down the government).

Read more at http://www.calculatedriskblog.com/#DuacR3cuZqT7jBP2.99