Stocks have a knack for confounding consensus expectations. If most prognosticators think X will happen, you can be relatively sure it won’t—Y, W or even Q are more likely. After a banner 2013, you’ll be hard pressed to find a pro who thinks stocks can finish 2014 up big again. And the bears, also, are less bearish. Most see stocks up in the mid-single digits—not bad, but not great. When sentiment settles to the middle you should expect something different: Extremes—up big or down a lot. Of the two, a huge up year seems much more likely. Fundamentals are positive, and while risks exist, we don’t see any big, probable or surprising enough to buck the bull. We expect forecasters to be surprised this year by strongly positive returns in 2014.
Bulls and bears alike expect an ok, if middling, year. For example, we compiled a list of 44 professional forecasters’ public predictions for the S&P 500 Price Index’s closing level. Two forecast negative returns—but their expected decline is smaller than -3%. Four forecast returns exceeding 10%, but none exceed 13.6%. The remaining 38 see returns ranging from 0.1% to 9.6%. The median return is a modest 5.8%. No forecasters see up big. None see down significantly, either.
This move to the middle isn’t very surprising. Bears are tiring of being the boy who cried wolf—they still see risk but think stocks can do ok for now. The bulls, meanwhile, are becoming less bullish, having contracted a case of acrophobia. Typically when this happens, markets will surprise both camps with an extreme year.
Of course, extreme could also mean extreme down. But bear markets don’t occur by chance. You usually need one or both of the following: Euphoric investors who don’t notice a deteriorating outlook for corporate earnings, or some big, bad, unexpected development with the potential to wipe a few trillion off global GDP (and, by extension, kick corporate profits). It’s hard to find much euphoria in 44 forecasts calling for a median return a bit below the market’s long-term average. Euphoric forecasts would call for a 2014 moonshot. Risks exist, but most are too widely discussed to have much meaningful market-moving power. Among the less-discussed risks, none appear likely to materialize in a significant way. The latest unintended consequence of the Volcker Rule, for example, might impact about $70 billion worth of bank assets. Big in absolute terms, but relative peanuts at 0.4% of US GDP.
Today’s underappreciated positives far outweigh the risks. For example, the global economy is strengthening—not a requirement for more bull market, as we saw in 2013—but economic fundamentals look especially sweet entering 2014. Leading Economic Indexes in most countries are high and rising—in many cases thanks to steepening yield curves as a result of markets’ anticipation of QE’s end. Corporate balance sheets are flush with cash, even as business investment approaches all-time highs, thanks to rising profits. Most manufacturing and services PMIs globally signal continued growth. The US and UK are gaining steam, the eurozone’s recovery is continuing, China is still exceeding growth targets and contributing heavily to global GDP, and most Emerging Markets are expanding at a decent clip.
The political climate is also favorable. Some point to relatively weaker historical returns during the second year of the US Presidential cycle, but year-two returns aren’t automatically bad. Historically, they’re just more variable. In years like this, where gridlock reigns, they tend to be quite good! Gridlock drastically reduces the likelihood of radical legislation that could spook markets. Gridlock is prevalent in the UK and Germany, too, limiting legislative risk in the most competitive advanced economies.
Not that folks should expect a straight shot up. Corrections are always possible. Corrections—steep, sharp drops that typically start without warning and last a few weeks to a few months—are quite common in bull markets. The MSCI World has had five since this bull began, and they’re a necessary evil for anyone seeking to capture market-like returns over time. Navigating around them requires near-perfect timing at the top and bottom, which is impossible to nail repeatedly—they’re driven by sentiment, which swings on a dime, not fundamental factors. They’re also unpleasant, but markets typically rebound quickly, rewarding those who tough them out as they weigh all the fundamental factors at work. With an accelerating global economy and strong likelihood of continued earnings growth, folks should have plenty of reasons to bid up stocks this year.