CI Outlook - Archives

January 2014

This year 2014, may be the year of the “Reluctant Bull”.  As noted in the chart below, 2013 was the year of “Raging Bull” the year the stock market finally broke out of its 14 year trading range.  During those years investors despaired, earnings soared and PE’s and yields plummeted. 

Entering 2013 stocks were undervalued and sentiment was negative.  Worries about an economic recession and budget sequestration kept investors on edge.  This year expectations for the economy are strong and Congress agreed to a budget before adjourning for Christmas.  So why wouldn’t this year to be better than last?  The answer lies partially in news headlines and partly in market valuations and interest rate expectations.

Consensus S&P 500 earnings expectations for this year are $118, a gain of 9-10%.  If the markets price earnings ratio holds steady we would look for a corresponding market gain of 9-10%.  We believe this is probable and do not look for the same expansion in PE’s as we had last year.  From these levels rising price earnings ratios would depend on falling interest rates.  And while the market has had the benefit of falling interest rates for the last few years, this is the year that is about to change.  As the Fed eases credit expansion and longer term rates rise it will become more difficult for the market to sustain an expanding PE.  And although a stronger economy and better corporate earnings seem likely, those expectations are already priced into the market.  Therefore any disappointing news will subject markets to higher volatility than in the last few years.  And after last year’s advance, many stocks have plenty of room to fall should they fail to deliver on expected sales and earnings.  So why do we think this market is a “reluctant bull” and not the “Raging Bear”?  If things are this dire why do we think there is still room for the markets to rise?  The answer lies in our longer term outlook.

As you know we have believed for several years that we are in the midst of a long term secular bull market.  One that will last through several business cycles, for a period of 12-15 years.  That advance will be punctuated by cyclical bull and bear moves corresponding to changes in the business cycle.  Normal cyclical bull and bear markets usually last between 18-36 months.  The current advance, or cyclical bull market, has lasted an extraordinary 54 months.  Its deepest decline has been less than 10%.  Due to its age and the current full valuation of this cyclical advance we believe 2014 will be a year of increased volatility and declines that may exceed the 5-6% dips seen so far in this bull.  However we think the Federal Reserve’s continuing policy of easy credit will cushion those declines and stave off a full blown cyclical bear market decline, which is usually defined as 20% or more from the markets high. 

While we expect 2014 to be a good year certain other factors may act to blunt the bulls advance this year.  Due to higher wage costs profit margins may come under pressure.  However we believe the effect of wage increases will be offset by stable commodity prices and easier bank credit.  The bull’s main obstacle will be higher long term interest rates.  Those rates will stifle the markets ability to expand PE ratios.  That expansion was the reason for last year’s exceptional advance.  Higher rates will also strengthen the dollar and lower demand for US exports.  But, while those companies dependent on exports for their profits may suffer, smaller and mid-sized US companies should continue to prosper.  Thus a strengthening domestic economy should bolster both profits and investor confidence as the year unfolds.  This combination should lead to another good year for stocks.  2014 should be a year of average returns, higher volatility and increasing confidence in the future.

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