Don’t expect another sizzling year for the stock market in 2014.
After a dazzling rally this year that left the Dow Jones industrial average with its biggest annual gain in a decade, several local investment advisers are predicting a less-than-stallar 2014, with below-average gains of 7 percent in both the Dow and Nasdaq Composite index.
The main reason: The Federal Reserve and its expected easing back on the bond purchases that have kept interest rates at historic lows since the Great Recession.
The advisers generally agree that the stock market has a lot going for it next year: an economy that will keep growing moderately, low inflation and the most stable federal budget situation in the last two years.
But the decision by the Fed to begin to taper its bond purchases, combined with the likelihood of further reductions next year, is shaking the advisers’ confidence that the rally can continue. Plus, they also say this year’s rally has left stocks fairly valued. Further gains in share prices would start pushing them into overvalued territory, they said.
Overall, Tim Johnston, the managing partner at Sandhill Investment Management, thinks the backdrop for the stock market heading into 2014 is pretty solid. Corporate profits are solid. The federal budget deficit is shrinking. The U.S. economy is slowly strengthening. The nation’s dependence on foreign energy is declining. And the Fed is moving to raise interest rates in a gradual manner.
“I think there’s a very good backdrop for a strong economy,” said Johnston, who expects the Dow and the Nasdaq to rise by 10 percent. “Much of it appears to be already in the market, so I think we’ll return to more normal returns.”
For the last few years, investors have been pouring money into the stock market because the Fed’s low-rate policies have depressed the yields on bank and bond investments.
Fears that the Fed could start tapering off the debt purchases that have been keeping rates low spooked the market earlier in the year, but the market responded positively when the Fed began taking steps to nudge rates higher earlier this month. How aggressive the Fed is in its moves next year will play a big role in shaping the direction of the stock market.
“Tapering by the Fed initially may jostle the market’s expectations, depending on the pace of the tapering,” said Anthony J. Ogorek, who runs Ogorek Wealth Management in Amherst and expects the Dow to rise by 11 percent and the Nasdaq to gain 9 percent.
“If the employment market strengthens more than the consensus expectations, rates may rise sooner than expected,” he said. “Inflationary expectations could rise if the markets believe the Fed is soft on inflation.”
Even if interest rates inch higher the average dividend yield on stocks still should easily outpace the yield on bonds. But any increase in interest rates would level an especially heavy blow to long-term bonds, which are highly sensitive to swings in rates.
For instance, a 0.5 percent increase in yield on a one-year Treasury bill will reduce its market value by the same amount. But that same increase in yield would slash the market value of a 30-year Treasury bond by more than 9 percent.
As the Fed begins to taper, that will make profit growth even more important, said Cynthia Vance, a certified financial planner at Jensen, Marks, Langer & Vance, a Buffalo money management firm, who expects the Dow to rise by 5.8 percent and the Nasdaq to jump by 8.1 percent.
“Earnings expansion is going to be paramount. The stock market is now what I would consider to be fully valued,” she said. “The stocks that can grow their earnings are going to be the stocks that do well in 2014.”
And that’s exactly what Bruce Kaz, the president of Buffalo money management firm Courier Capital Corp., expects to happen. Kaz thinks the earnings generated by the members of the Standard & Poor’s 500 stock index should reach a record high in 2014, which will help offset the headwinds created for stocks by the Fed’s taper.
Kaz calls that “a really good trade-off.” The result: “A solid environment for stocks, another year of challenges for bonds,” said Kaz, who expects the Dow to rise by 10 percent and the Nasdaq by 13 percent.
Despite the big run-up in stock prices this year, shares, on the whole, are fairly valued, said Stephen R. Robshaw, the president of Robshaw & Julian Associates, an Amherst money management firm.
“The market isn’t in a bubble,” said Robshaw, who nevertheless expects a lackluster year for stocks, with the Dow rising by 6 percent and the Nasdaq inching up 3 percent. “We’re just getting back to normal levels. The market is no longer cheap, but it’s not overvalued.”
But not everyone is so optimistic.
“Much, if not all, of the returns generated in the recent past were strictly on the basis of easy money,” said Gerald T. Cole, the managing partner at Arbor Capital Management, an Amherst money management firm.
“The Fed faces a conundrum that is similar in some respects to tricky winter driving conditions. It needs to slow down but sudden moves can also be disastrous,” said Cole, who is the most bearish local adviser on the panel, predicting a 7 percent drop in the Dow and a 10 percent decline by the Nasdaq.
He also thinks the federal health care initiatives could slow job growth and add to the stock market’s volatility. And as interest rates rise, investors likely will reduce the premium they now are willing to pay for stocks, relative to their earnings.
“In the stock market, what goes up always goes down. Hard,” said David Hartzell, the president of Clarence money management firm Cornell Capital Management.
“The market can’t go on rising forever, ” said Hartzell, whose predictions of a 3 percent dip in the Dow and a 7 percent decline by the Nasdaq next year make him the second bearish member of our panel.
And while Hartzell said it’s only natural to expect the market to lose some momentum after such a strong rally, it’s the Fed’s pullback from the aggressive bond buying that has pushed interest rates to rock-bottom levels that will throw the biggest bucket of cold water on stocks next year.
“The Fed is committed to a return to normalcy,” Hartzell said. “All of this is fine, and good over the long run for our economy. But stocks usually take it on the chin when interest rates rise.”
Above all else, remember that no one really can predict what the stock market will do with any degree of certainty.
“The vast majority of returns in any given year are caused by surprises and by definition surprises are non-forecastable, thus neither are returns,” said Thomas R. Emmerling, the managing partner at Dopkins Wealth Management in Amherst, who expects the Dow to rise by 6.5 percent and the Nasdaq to do a little better, with a 7.5 percent gain.
The danger to investors, Emmerling warns, is that those surprises can trigger an emotional reaction that can derail even the best thought-out investment plan.
“Emotion is what makes investing hard, it persuades us from our financial plan, selling when the markets are down because we are fearful and buying when the markets are at records highs, because the timing feels safer,” he said.