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What Will The New Year Bring For Investors?

2014

What Will the New Year Bring for Investors? by Zacks Investment Research

We are just days away from closing the books on a very good year for the stock market. The broad consensus is for the trend to continue into the New Year, pushing the indexes to ever higher levels. Driving this optimism is a combination of the improving domestic economic scene, signs of life in Europe, a less worrisome Chinese outlook and a still-supportive interest rate backdrop.

So is that it? Should we find assurance from the all-around air of optimism and stop worrying about the market?

The bullish case for the market sounds quite plausible, but I don't buy it.

My reading of the ground realities leaves me reasonably confident that the going will be a lot tougher for the market in 2014 than was the case this year. I envision the market to stall out and most likely give back a fair amount of its 2013 gains in the coming year.

You don't have to fully agree with me. In fact, many of my colleagues here at Zacks don't buy into my market outlook either. But if you stick with me a little longer, you will see that my outlook is firmly rooted in fundamental arguments.

I am not making a recession call, though I don't agree with the consensus view of a material ramp up in economic growth either. My outlook reflects the U.S. economy sustaining its recent moderate growth pace in 2014. The same goes for corporate earnings. I am not calling for an earnings train wreck, but I don't see how earnings could miraculously start growing at the consensus' double-digit rates in 2014 either.

What I am saying instead is that these 'middling' and 'average' fundamental attributes are inconsistent with a stock market pushing ever higher, particularly in the absence of the Fed's QE largesse. We don't know whether the Fed will pull the Taper trigger next week or not. But we do know that it's coming sometime in the not-too-distant future. The eventual end to the Fed's extraordinary QE program will make it difficult for investors to overlook these less-than-inspiring fundamentals.

A challenging investment environment doesn't mean you should head for the hills and exit the market altogether. There will still be plenty of profitable investment opportunities in the stock market in 2014. But you will need to be a lot more selective in making stock picks than has been the case lately.

A Critical Look at the Fundamentals

Here are reasons why I find it difficult to buy into the 'all-is-good' consensus narrative:

1) The Fed's Taper Dance: Hard to believe that there are folks who see no correlation between the stock market's impressive performance this year and the Fed's enormous bond purchases. But they are there and they see no consequences for the stock market once the Fed changes course. Needless to say that I am not in that camp. I see the Taper announcement and subsequent QE end as much more than just a technical hiccup for the market. The Fed kept the yield curve under its thumb with the QE program, but it's ability to influence long-term interest rates will be a lot weaker than many in the market seem to appreciate.

2) U.S. Economy - Hope Springs Eternal: Over the last few years, there has been an unmistakable optimistic tone to U.S. GDP growth forecasts at the start of each year. These forecasts can't escape the underwhelming reality of the current and coming quarter, but they hold out hope for better times ahead in the 'second half' of the year. The current consensus outlook for 2014 is no different. We had an inventory build-out that drove Q3 GDP growth to 3.6%, but the growth pace will barely reach half that level in the current and following quarters. But growth is expected to miraculously ramp up in the second half of the year and continue accelerating into the following year. My view is that it's good to be hopeful in life, but 'hope' shouldn't form the basis for your investment outlook.

3) International Backdrop - Better Than Before, but Hardly 'Growthy': The outlook for Europe has clearly improved, but the improvement is more in terms of lower downside risks rather than better growth prospects. Something similar appears to be at work with China, with the 'hard-landing' scenario now off the table, but the country's double-digit growth rates of years past are not coming back either. The outlook for the other major emerging economies like India, Brazil, Indonesia, Turkey, and others is fairly uncertain, with the growth picture expected to worsen in a post-QE world. All in all, the global economic growth picture should be only modestly better than what we had this year.

4) Corporate Earnings - 'Hoping for the Best': Earnings growth has barely been in the low- to mid-single digits over the last many quarters as the cycle has aged. But consensus expectations are for a growth ramp-up in 2014 that continues into the following year, with total earnings for the S&P 500 expected to be up 10.9% in 2014. Count me as skeptical of these forecasts. With margins already peaked out and revenue gains hard to come by in a growth-constrained world, these expectations may not be much different than 'hoping for the best'. These estimates will most likely come down, as has been happening repeatedly quarter after quarter for more than a year now. And the market will most likely be a lot less forgiving of persistent negative estimate revisions in a post-QE world as it has been in the recent past.

Making It Work for You

This may not sound very uplifting, but there are always profitable investment opportunities even when the broader stock market indexes are in the red. You don't need to do rapid-fire trading to take advantage of those opportunities, but your odds of coming out ahead increase significantly should you reposition your portfolio ahead of time.

Each year, we combine the top-down approach explained here with a rigorous bottom-up stock selection process to come up with our Zacks' Top 10 Stocks portfolio. In 2013, we had a phenomenal +40.1% return through the end of November, handily beating the S&P 500 index. In 2012, the Top 10 portfolio nearly tripled the market's performance, with returns of +31.7% vs. the +12.1% returned by the S&P 500.

We are about to come out with the Zacks' Top 10 Stocks for 2014. There is obviously no guarantee that we will be able to repeat our past outperformance in the coming year, but having a robust framework in place puts the odds in our favor.

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