We are in the midst of a secular bull market. This is the most hated bull market that I can recall during my career which began on Wall Street at Morgan Stanley (MS) in 1984. Unfortunately, most of today’s market participants; especially those under the age of thirty-five have never experienced a secular bull market. To understand the current bull market, you would have had to been in the business or were actively investing in the 1980s secular bull market from 1982 – 1989 or the 1990s technology led bull market from 1995 – 1999. Most of the modern day market participants tend to be day traders who focus on technical analysis and only see the world through the eyes of the post-tech bubble bear market and post-financial crisis bear market.
There were no significant corrections in 2013. Pullbacks were shallow and fleeting. Social networking stocks finally took off like a rocket ship while bonds were grounded and will likely be so for many years to come. The US consumer continues to spend money and also repair their balance sheets. If you tried to get cute in 2013 and move to cash or hedge off your portfolio, you paid for it dearly. Outperforming the market was not so easy because the tide was lifting all boats.
2014 will not be as easy as 2013 but it also will not be pleasant for the bears and hedge funds, both of which have suffered from performance issues during this bull market. As is the case for all years; 2014 will deliver its highs and lows, surprises, intrigue and will humble investors and traders, whether professional or do-it-yourself. Adding to this year’s fun will be an important midterm election. For the record, during midterm election years, the S&P 500 (SPX) delivers, on average, slightly negative returns for the first three quarters followed by a superlative fourth quarter. In fact, the fourth quarter of the midterm election year, on average is the best of the sixteen election cycle quarters for the SPX. Thus, if history holds true to form, we should have a back ended year for investors.
As always, I am not going to try to be outrageous but rather will be practical and analytic as I present, My Gut Feeling for 2014:
- The SPX ended 2013 at 1,848.36, which using Standard & Poor’s earnings estimates of 107.25, implies an index price/earnings multiple of 17.25. Bottom up estimates for 2014 earnings as complied by Standard & Poor’s for its SPX index are expected to increase by about 13.3% to just around 121.51. Given stronger than expected Gross Domestic Product (GDP) in the second half of 2013, once the dust settles, SPX earnings for last year should come in at 107.50. In 2014, my expectations are for 8% nominal earnings growth with another 3% of anti-dilutive earnings growth due to buybacks. Hence, my SPX earnings estimate is about 119.33. The SPX earnings multiple should continue to accelerate to 18 in 2014 and 19 in 2015. Hence, I am setting a year-end target for the S&P 500 at 2,148, about a 16% year-over-year increase. When the SPX crosses 2,000 it will cause a media sensation.
- The bond market got its first taste of an expanding economy and reduction in the Federal Reserve Open Market Committee quantitative easing asset purchase program. The 10-year US Treasury yield surged from 1.76% at the end of 2012 to 3.03% at the end of last year. I foresee further backup in 2014 to 3.75% which is enough to chase more investors out of bonds.
- United States corporations are leveraged to growth in US Gross Domestic Product (GDP) as a result of cost controls, low wage pull inflation and strong balance sheets. Furthermore, the US economy is secondarily leveraged to what I expect to be improving economies in Europe and China. Latin America, other than Mexico, especially Brazil will remain in the economic doghouse. Increasing crude oil and gasoline inventories will keep domestic energy prices low, helping to spur consumer activity and economic growth. My expectations are for real US GDP to grow from an average of 3.0% in 2013 to an average of average of 4.375% in 2014. Unlike 2013, real GDP growth will be smoother, primarily as a result of a less contentious budgetary process in Washington D.C. On a quarterly basis, I expect GDP in the US to grow by: 4.0% in 1q; 4.0% in 2q; 4.5% in 3q; and 5.0% in 4q.
- 100 point moves in the Dow Jones Industrials (DJIA) and 10 point moves in the SPX will become more commonplace. That will not be as a result of increased market volatility. Rather, it is just the mathematical reality of higher market index levels. However the financial media won’t get it as they see the world through an absolute rather than relative perspective. From a relative perspective, 100 Dow Jones points in 2014 is akin to about 60 points ten years ago.
- Gold, which declined in 2012 for the first year, so it seems, since my Bar Mitzvah, will not fare much better in 2014. However, the glittery metal which closed at around $1,205 after an approximate 28% crash in 2013 will experience a bear market rally in 2014, most likely in the first half of the year. However, once the year is over, gold will resume its decline.
- After several years of excellent stock market returns, in 2014 several underperforming CEOs will get the axe. Some compassionate boards will allow those CEOs to retire or step aside for family reasons. Possible candidates are Cisco’s (CSCO) John Chambers, McDonald’s (MCD) Don Thompson and Caterpillar’s (CAT) Douglas Oberhelman. Those three corporate leaders don’t stand alone as there are plenty other CEO candidates for the unemployment line. CSCO rose about 9% in 2012 and 14% in 2014. MCD declined 12% in 2012 and rose about 10% in 2013. CAT was barely changed in 2012 and 2013. Compare all that to the SPX which rose by 13.41% in 2012 and 29.60% in 2013.
- The Sochi Winter Olympics will be a public relations nightmare for Russia. The event will be plagued by old style Russian cheating and new style Chechen political unrest. A terrorist attack during the Olympics, either at Sochi or elsewhere in Russia will precipitate a global market pullback of 5 – 7%.
- Republicans pick up seats in both the Senate and House of Representatives but fail to hold a Senate majority. Nancy Pelosi is forced aside as minority leader. With Pelosi out of the picture and Steny Hoyer being seen as too old, the Democrats select Xavier Becerra as their new house leader in order to get younger and place a Hispanic in a senior position ahead of the 2016 Presidential Election which could have some Latino Republicans make a serious run at the White House.
- Microsoft (MSFT) cannot find a compelling or willing candidate to replace CEO Steve Ballmer. Already Ford’s (F) Alan Mulally has said not to bother asking. Bill Gates realizes that his efforts in Africa are just a waste of time and money as Barron’s recently pointed out. Gates attempts a second act as CEO for Microsoft, hoping to do for that software company what the late Steve Jobs did for Apple (AAPL). In the long run, Gates will fail where Jobs succeeded.
- Google (GOOG) will take several corporate actions, this time in an investor friendly way. The company will declare a dividend equal to 2% on a yield basis. Furthermore, a $10 billion buyback funded by debt will be authorized. Finally, the stock will split 5 or 10 for 1 in a pre-arranged move to gain acceptance in the Dow Jones Industrial Average Index, allowing Dow Jones to offset the weakness in its second largest constituent, International Business Machines (IBM). The victim of GOOG’s inclusion in the DJIA will be the aforementioned CSCO.
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Disclosure: At the time of this commentary Scott Rothbort, his family and/or clients of LakeView AssetManagement, LLC was long AAPL, F and GOOG — although positions can change at any time.
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Scott,
Great to read a bullish perspective. I have to admit that your analysis of 2013 is spot on–it looks, feels, and smells like a bull market. I also liked your specific references to corporate earnings, and here is a FactSet link you might like: http://www.factset.com/websitefiles/PDFs/earningsinsight/earningsinsight_1.3.14/at_download/file
There is lots of investment commentary on the Internet that is pessimistic and cynical, and not enough that considers the upside.
Rob
VIX broke below my 33 level and bounced right back. I would sell VIX Puts here. I do not think this will last long tuoghh, I thing the VIX 200 EMA is where I would close the position.One more big pullback… I think the next rally carries us out.I have no idea what to expect on the stress tests. Honestly, I think more and more that no news matters. Look at the ADP numbers. That is probably the only reason we did not have a bigger sell-off, but when the market is ready to reverse, the news flow doesn’t seem to matter.