The S&P 500's (NYSEARCA:SPY) tremendous gains in 2013 have left many investors uneasy about sustained future growth. Goldman Sachs (NYSE:GS) recently released their market forecast for 2014. The firm's Chief US equity strategist, David Kostin stated the S&P 500 would continue its record-setting rally into 2014, reaching 1900 by the end of next year. As bullish as this seems, this is only a 6% gain from where the market is now versus the index's 26.38% return YTD. Kostin expects the market to reach 2,100 in two years, a gain of 17% and 23% to 2,200 by the end of 2016. The Organization for Economic Cooperation and Development (OECD), in its most recent economic outlook, forecasted global growth at 3.6% in 2014. The basis of their position is that emerging markets are beginning to waver and expansion worldwide is susceptible to an assortment of risks.
In the US, there is still dismay amongst investors about future Fed policy. After the release of better than expected economic data including retail sales and jobless claims, concerns have been temporarily suspended. Consensus amongst most FOMC participants (Federal Open Market Committee) from its most recent meeting is that curtailing quantitative easing should not be done automatically, but rather based on economic data. As the Federal Reserve keeps interest rates low and continues buying government bonds at approximately $85 billion a month, this allows corporations to borrow money inexpensively and encourages people to invest in stocks. Although bond prices have slipped in November as some fear the Fed may trim the monthly debt-purchase program as soon as this month, the yield on the 10-year Treasury note increased to 2.746% from 2.739% on Wednesday. There have also been some positive signs lately as the Dow (NYSEARCA:DIA) managed a record close and the Nasdaq (NASDAQ:QQQ) crossed 4,000 for the first time in 13 years. The Dow Jones advanced 3.5% in November and set 12 closing records. The Standard & Poor's index fell earlier last week, when energy shares retreated following diplomat's agreement with Iran concerning their nuclear ambitions. However, both the S&P 500 and Dow have each risen for eight consecutive weeks. This is the longest streak for the DJI in two years. This index was up as much as 77 points Friday but finished down 10.92 points or 0.1%. The S&P 500 dropped 1.42 points on Friday but finished the month up 2.8%. This is the longest streak of weekly gains since a nine-week stretch that ended January 23rd 2004. The Nasdaq Composite raised 3.6% this past month. In order to assess growth this past year, Chart 1 shows the return of what some major U.S. indexes have accomplished YTD.
The S&P 500 in blue has shown vigorous growth in 2013, almost 27% YTD. The Dow Jones Industrial Average in red has done so as well with a return of 22.64% YTD. Most impressive of all is the Nasdaq Composite in yellow, which has returned 32.28% YTD. Wal-Mart reported strong traffic in stores and online which was open Thanksgiving Day. Another notable component Apple, reached its highest price of $556.50 on Friday and Amazon rose 1.8% to $393.62. Conversely however, the Chicago Board Options Exchange Volatility Index leaped 12% last week, the largest one-week gain since the shutdown of the US government.
U.S. Market Forecast For 2014
Clearly each index has had substantial growth in 2013; however, investors seek some level of assurance of whether this growth is sustainable into next year. I Know First utilizes an advanced algorithm based on artificial intelligence and machine learning to predict market performance for over 1,400 markets including stock forecasts, world indices, commodities, interest rates, ETFs, and currencies. The system follows the flow of money from one market into another.
The algorithm denotes a long position on all three of these indexes for the 1-year time horizon. In the 3-month time horizon, the algorithm is showing a bullish position for Standard & Poor's 500 as well as for the Nasdaq Composite but is still short for the Dow Jones Industrial average for this time horizon. However, in the 1-month prediction, the algorithm is bearish for all three. Mr. Kostin states there is a 67% possibility that the S&P 500 could endure a pullback of at least 10% as they have projected more volatility in the markets. Chart 2 is screen shot of one type of output from the algorithm in the form of a heat map. In each box of the heat map, there is the ticker symbol, the signal and the predictability indicator. When reading this forecast, please note that forecasts with longer time horizons tend to be more accurate than short-term predictions.
The number in the middle of the box (flush right) is the signal. The signal expresses the predicted direction and magnitude the algorithm believes an asset will move, not a percentage or specific target price. A bigger number signifies a stronger signal. The signal also dictates the color and location an asset is on the heat map. If the asset has a positive signal it will be in a grey/green box denoting a long position and if the signal is very strong the asset will be in a lime green box demonstrating that the algorithm is strongly bullish. The same is true for a negative signal with the pink and red respectively denoting a short position. Assets with the strongest positive signals will be closer to the top left of the heat map while, the strongest negative signals will be towards the bottom right of the heat map. In this 1-month time horizon of Chart 2, the signal for the S&P 500 and Nasdaq Composite are relatively weak. In addition to monitoring the signal, it is imperative to take into consideration the predictability. This is the "strength" of the prediction, which ranges theoretically between minus 1 to plus 1. The predictability shows us another independent indication regarding how foreseeable the market or asset is as different markets/assets are not equal. We elaborate further here.
Chart 3 presents the predictions the system forecasted of the S&P 500 over the past year from October 5th 2012 until November 27th 2013. The thick blue line shows the actual price. The thin broken color lines on the chart are the signal lines. These signal lines are the algorithm's predictions.
The positive or negative (up or down) signals of the forecast were added to the actual last known price at the time of forecast. Thus, when the signal line is above the actual line, it means, "buy", if below, then "sell". Each point on this chart was taken from the actual daily forecast published in the morning before the next market open. Each forecast consists of six forecasts for six time horizons, from three days to one year ahead. One can see that the signals varied in strength throughout the year. The weakest signals were during three periods of indecision: from the end of December-to-beginning of January, in mid-June to mid-July, and also recently, since the second half of October. These were the periods when the system was uncertain about the future. However, for most of the year the signals were positive-to-strongly positive.
Gold Forecast for 2014
Just as Goldman Sachs has a negative forecast for gold (GLD), the I Know First gold forecast is also very bearish. The bank expects a significant decline of at least 15% in commodities such as gold, copper, iron ore and soybeans in 2014. There are others who agree as well. UBS Bank, one of the largest traders in the gold market, reduced its price conjectures for this precious metal. The bank lowered its one-month target to $1,180 a troy ounce from $1,450 an ounce, and cut its three-month target to $1,100 an ounce from $1,375 an ounce. Gold traded around $1,245 an ounce on Tuesday. At the end of the summer on August 25th, I Know First's algorithm recommended a short position. Three months later it dropped 10.7% as of November 25th. Chart 4 includes I Know First's forecast for physical gold (XAU) from November 28th. It is clear that the algorithm is bearish in the 1-month, 3-month, and 1-year time horizons.
So why is the consensus bearish? For years, gold was perceived as a safe haven during times of commotion or as an inflation hedge against the Federal Reserve's easy-money policies. Investors also often have gold as a hedge against rising consumer prices or depreciating currencies. However the market has changed as the precious metal had very little price reaction to the United States government's liquidity measures, which is a new behavior from how gold has acted historically. This is partially due to the fact that perhaps the public has become numb to the nonsense on Capitol Hill. GLD is down 25.5% YTD and many investors are now leaving gold as they expect the central bank to start dialing back its bond purchases in the near future and inflation expectations remain low. However, not everyone agrees with this position. Hedge-fund manager David Einhorn of Greenlight Capital told CNBC that he plans to keep holding gold "in case things go haywire," referring to monetary policies as well as the fiscal policies of the big economies.
For many people in the U.S., times are still difficult. Consumer debt is $3 trillion and rising, and unemployment is still above 7%. On the other hand, earnings of S&P 500 and Dow Jones are at a record highs and the Nasdaq recently crossed 4,000 for the first time in over a decade. I Know First's algorithm is currently denoting a long position on these indices for the 1-year time horizon and a short position for the 1-month and 3-month time horizons. For the precious metal gold, the algorithm is bearish for each time horizon. This advanced system relies mainly on technical factors but is very complex. The algorithm utilizes fifteen years of historical data and is updated daily so each prediction has the potential to change as new information is added each passing day. While Wall Street has been on an upward trend, Main Street has not had the same story. Investors should also consider this factor when fashioning an outlook of the overall economy for 2014.
Business relationship disclosure: I Know First Research is the analytic branch of I Know First, a financial startup company that specializes in quantitatively predicting the stock market. This article was written by Joshua Pastore one of our interns. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.