It was easy to be bullish heading into 2012 and 2013.
Profit growth was returning, the Fed was still ready and able to add support to the U.S. economy, valuations were attractive across the board, unemployment was still high but improving, the S&P 500 was well below record highs, and — most important of all — there was much less bullish sentiment.
It’s always a lot more fun to be bullish when the majority of investors are bearish. It also tends to be more profitable…
When bullish sentiment is low, the stock market tends to have more upside. There’s more room for upside surprises from both earnings and economic data. People aren’t fully invested, so there is likely plenty of cash on the sidelines.
When people expect the worst, they are usually disappointed.
Between 2009 and 2012, investors were pretty bearish. They didn’t like or trust stocks or the stock market. And so, in those years, they plowed a massive $1.3 trillion into bond funds. At the same time, they pulled a net $75 billion out of stock funds.
The tide changed in 2013. Investors finally got bullish. Bond funds got only around $16 billion in new money, while stock funds attracted $193 billion. Close to another $150 billion went into stock ETFs.
This is the primary reason we say it’s more difficult to be wildly bullish now than it has been for the last few years.
The Case for Caution in 2014
There’s an old saying you’ve probably heard before: “The market can stay irrational longer than you can stay solvent.”
Now, we’re not saying the market is irrational. The point here is that stocks can go against your expectations for a long time.
In 1996, for example, former Fed chief Alan Greenspan gave his infamous “irrational exuberance” speech. The Dow was around 4,500 at the time.
It would run higher for four more years. The P/E ratio for the S&P 500 peaked around 33 just a few months before the Internet bubble popped. Earnings per share grew from $49 at the start of 1995 to $68 at the start of 2000.
Let’s not forget there was a lot to like about the U.S. economy in the late 1990s: the federal government was running on a surplus, there was a considerable peace dividend, GDP growth was strong, wages were rising, productivity was very high, the Internet was pushing technological innovation, and the completion of the human genome project would usher in a whole new way of treating diseases.
Today, the S&P 500 trailing P/E is 19. And instead of a checklist of bullish catalysts, we now have a laundry list of negatives: high Federal government deficits, high unemployment, weak GDP growth, stagnant wages, relatively high gasoline prices, and the ongoing uncertainty surrounding the Fed and QE.
Earnings per share for the S&P 500 have gone from $63 a share at the start of 2010 to $109 for 2013. And while that $109 a share is a record, it represents just 4.7% growth over 2012 earnings per share.
Sure, growth is good. But the growth in stock prices far outpaced the growth in earnings. Multiple expansion — that is, rising P/Es — was responsible for the majority of the S&P 500’s 29% advance in 2013.
Some degree of multiple expansion is appropriate. That’s because as the U.S. economy has stabilized, earnings have become more reliable. Also, individual investors coming back to the stock market helped push valuations higher.
Now, let’s have a look at what Wall Street is expecting for the new year…
2014 Predictions
For 2014, earnings are expected to grow 9.7%. That’s almost twice the rate of 2013, according to analyst estimates compiled by Bloomberg. Profit growth will come as sales increase 3.8%, up from 2.2% in 2013.
Expected revenue growth for 2014 is currently 3.8%, according to Thomson Reuters data, after an estimate of just 1.8% in 2013.
Analysts expect the U.S. economy to expands 2.6%, faster than last year’s 1.7%.
Bloomberg says 1,955 is the average forecast for the S&P 500 in 2014. That’s just a 6% advance, and it’s because valuations are a bit on the high side. In other words, earnings need to be pretty darn good in 2014 to justify even a small advance for the S&P 500.
Clearly, analysts and strategists are in a conservative mindset as the bull market extends into its 5th year. Even so, we have to note that expectations are high, as evidenced by P/E numbers. If earnings disappoint, we could see a sharp correction of more than 10%.
There is also potential upside from the U.S. economy. Growth has obviously been weak at 1.7% in 2013 and perhaps 2.6% for 2014.
But at some point, growth will break out. Corporations have a huge amount of cash, and at some point, demand will return and corporations will hire again. Will that be in 2014? Who knows?
This looks like a good spot to go ahead and list our Top Predictions for 2014. We’ve given you a rundown of what Wall Street thinks. Now here’s what we think lies ahead…
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We WILL NOT see a 10% correction in 2014. This one speaks for itself. The reason for this bullish call is that we think 2014 is the year the U.S. economy starts cooking again. By the end of the year, we expect to see GDP of 3.5%, surprising everyone.
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Russia will be the source of a moderate economic crisis. Russia’s resource-based economy is already struggling, and there’s a strange post-Olympic depression that tends to hit host countries. Even though we expect oil prices to be strong, Russia (not China) will suffer a crisis of confidence
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U.S. GDP will beat expectations in the second half. Full-year GDP growth will hit 3.5%, but we also think we’ll see blowouts above 4% in the 3rd and 4th quarters.
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Gold will trade as high as $1,500 an ounce. Gold will put in a nice rally in the first half of the year, peaking at ~$1,500, but then stronger growth will take over, and gold will trade lower in the second half.
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Strong economic growth and the prospect of legalizing U.S. oil exports will push WTI to $120. Energy was a so-so performer in 2013. In 2014, oil prices will break out — big time. In fact…
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Social media stocks will underperform, and energy will be the best-performing sector of the S&P 500, followed by financials, materials, consumer discretionary, and technology. Maybe it’s silly to question the upside of “unlimited growth” stocks like Twitter. But with a big lock-up ending in May, we think the stock will get whacked.
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Home construction will improve dramatically, helping push employment numbers. How’s this for a contrarian call? So far, rising interest rates have squelched mortgage demand. But that trend changes this year. More people will get jobs, wages will start rising, and that will get a flood of home-buying started.
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The Baltimore Orioles will win the World Series. Hey, what the heck, right? Nobody remembers predictions anyway, or so we hear…
That’s what I got… We’ll see how it plays out.
Until next time,
Until next time,
Briton Ryle
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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.
