2014 Stock Market Outlook: More Gains

Five years into a powerful bull market, there seems to be little on the horizon to cheer up the bears.

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Bull figurine on ascending line graph and list of share prices
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By Anne Kates Smith

So the phenomenal rally raises the question: Where is the market getting its strength? And more important, can this aging bull continue to run? Our answer: Don't give up on the bull yet -- it may be younger than it looks. "We don't see a bear market coming," says Henry Smith, chief investment officer of Haverford Trust. "We believe that March 2009 represented a generational low, and that this is the middle of a sustained bull market."

Another year of gains will be supported by stronger economic and corporate underpinnings, and, just as important, improving sentiment among investors. By most measures, stocks are fairly priced, if not bargains. Given expected earnings growth of nearly 10 percent in 2014, we think stock prices could rise that much and perhaps more if investors again prove themselves willing to pay more for each dollar of corporate profits, ratcheting up the market's price-earnings ratio. A reasonable range to expect would be 8 percent to 12 percent returns, including dividends. An 8 percent price gain would put the S&P 500 (^GPSC) in the vicinity of 1,944, translating into roughly 17,300 on the Dow Jones industrial average (^DJI); a 10 percent gain would put the S&P 500 at 1,980, the Dow a bit over 17,600. With dividends, the S&P's returns could reach 12 percent.

Despite the wounds inflicted by squabbling lawmakers in Washington, the U.S. economy will continue to improve in 2014, with gross domestic product growing 2.6 percent, up from our estimate of 1.5 percent in 2013. For the first time since the Great Recession, consumers will see wages grow faster than inflation, with personal income rising at least 3.5 percent and inflation about 2 percent.
Companies will continue to add to payrolls, with the unemployment rate fluctuating between 6.9 percent and 7.2 percent as more people decide to resume searching for work. To keep the economic wheels greased, the Fed will likely keep short-term interest rates near zero until 2015, but longer-term rates will rise as investors begin to anticipate an acceleration of economic growth. Look for the benchmark ten-year Treasury bond to end 2014 with a yield of 3.3 percent, up from 2.8 percent today.

Housing is a pocket of economic strength, with new-home sales expected to jump 16 percent. Outside the U.S., exports could rise by 4 percent as Europe's economy convalesces and China's slowdown levels out. Economists at IHS Global Insight expect global economic growth of 3.3 percent in 2014, up from an expected 2.4 percent in 2013. Among the challenges in the U.S. will be the fiscal uncertainty that bleeds into early 2014 as Congress wrangles with the level of government spending and with raising the debt ceiling (also known as giving Uncle Sam the wherewithal to pay his IOUs).

But the Federal Reserve holds the real wild card. Most Fed watchers expect the central bank to begin cutting back its massive, $85-billion-per-month bond-buying program in the first quarter. Last summer, the market swooned at mere rumors that the Fed was set to taper its stimulus. Dan Morris, global investment strategist for TIAA-CREF, notes that from the time the Fed's two previous "quantitative easing" programs ended (in March 2010 and June 2011) until the next easing program was hinted at, the S&P 500 fell 9 percent and 12 percent, respectively.

At taper time, "the markets will take fright, yields will go up, there'll be volatility," Morris says. "You could see a 10 percent correction, but people need to ride through it."

The Upside of Fed Tightening

That's because tapering won't commence until the economy is robust enough to withstand it. Recall the surprise when the Fed confounded market expectations by not tapering last September. The implication, says BMO Capital Markets strategist Brian Belski, is that tapering won't begin until "there is incontrovertible evidence that the economy has reached escape velocity." And you can expect much the same Fed policy to continue when Janet Yellen moves from board member to chairman early in 2014.

When it comes to corporate earnings, investors should focus less on absolute growth rates and more on the nature of the profits. After strong gains at the start of a recovery, it's not unusual for earnings growth rates to flatten out. But a profit peak is still years away, says Christopher Hyzy, chief investment officer of U.S. Trust.

Conspicuously missing from the profit picture in recent years has been a convincing pickup in revenues; instead, companies have engineered big chunks of profit gains through relentless cost-cutting. That could change in 2014 as consumer and business demand for goods and services finally picks up, and sales become a greater factor in driving profits. The period "is likely to be characterized as the dawn of a new business cycle," Hyzy says.


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drbobdez

pdbliz, you may want to temper your admonishment with a few facts. When the Bush administration came to office, it inherited a $9,523 million surplus. Over the next eight years, it ran up a deficit of $932,561 million (two wars, a tax cut [38% of which went to the top 1%], lowering the top tax bracket by 4.6%, etc.). Just because the administration left, it did not mean that the bills stopped coming. All this was exacerbated by the financial meltdown that followed the administration's departure. The deficit was accompanied by a handsome chunk of interest since it was financed with debt (it doubled over the eight years). The current administration has reduced the deficit by almost 75% ($213,982 million in 9/13) in about four years. Nevertheless, the national debt grew by 40%. Why? The shrinking tax base because of unemployment; the refusal of the House to raise revenue; the ongoing expense of the two wars; the mounting interest on the extant debt; the increase in public assistance for those out of work; assistance to states who saw their tax bases decline because of the housing collapse; +;+;+. Although a highly simplistic example, the situation is similar to the plight of the contemporary college student. One cannot run up a huge debt during college and expect it to evaporate upon graduation. Nothing happens in "zero time." And, it usually takes much longer to repair a financial mess than it did to create it. I will defer the impact of income inequality on all this for another discussion.

November 27 2013 at 1:03 PM Report abuse +2 rate up rate down Reply
toosmart4u

Way to go President Obama, doing a very good job. It has been rough cleaning the mess of former president bush jr. and the republicans.

November 27 2013 at 6:58 AM Report abuse +2 rate up rate down Reply
2 replies to toosmart4u's comment
pdbliz

SMART...............I HAVE TOLD YOU ONCE,,I HAVE TOLD YOU DOZEN TIMES IN THE LAST WEEK,,,,,
BUSH IS GONE........DEMOCRATES OWN THE LAST 6 YEARS,,,,AND,,,OBAMA CARE MAY BE THE END TO SOME DEMOCRATES.!!!

November 27 2013 at 7:27 AM Report abuse -1 rate up rate down Reply
dweeeb.buster

With food stamps at an all time high, and the percentage of the population participating in the workforce at an all-time low, "let them eat cake" bleats a dumbest 1%er

November 27 2013 at 9:33 AM Report abuse -2 rate up rate down Reply