While my firm is generally bullish for 2014, I think market action in the first quarter will prove more volatile than what investors have grown accustomed to. Historically, the first quarter has been seasonally favorable for equities. However, I’m observing several factors that are likely to raise volatility and cause a short-term sell-off in the first quarter of the year. The big question is whether the pullback will be limited to the 3% to 5% range, or if investors will have to get reacquainted with the emotions associated with a 10%-ish correction. I suspect the latter is increasingly likely.
Most importantly, I expect a significant performance divergence among the 10 sectors of the S&P 500
(INDEXSP:.INX), as well as a continued drop in asset-class correlation. In other words, active portfolio management will likely prove paramount in 2014.
Economic growth in the US as well as internationally is uneven yet improving.
Fourth-quarter corporate earnings will likely be stronger than most forecast -- more focused on GE (NYSE:GE) and other industrials than Alcoa (NYSE:AA).
Capital expenditures are rising and corporate risk aversion is fading, leading to more investments.
Fuel and energy costs are dropping, likely helping many companies' profit margins.
Washington, DC, is still dysfunctional and has yet to pass a long-term budget
Asian economic data, principally from China, has weakened a bit
An End to QE? Not So Fast...
Many investors will face a higher tax bill than previously estimated, which could cause a profit-taking sell-off
While the Federal Reserve surprised me and many others by announcing that it would begin tapering asset purchases in January, investors should not view this as an end to loose monetary policy. Chairman Ben Bernanke as well as incoming Chairwoman Janet Yellen have both stated (as have virtually all other Fed governors have) that interest rates are expected to remain low for a very long time, and that any changes in policy, -- including further tapering -- would be “data-dependent." The most likely scenario for tapering of asset purchases is that the FOMC will monitor and analyze the impact of the first round of tapering before making further adjustments. As such, I expect asset purchases in January and February to be at the $75 billion-per-month level. If economic conditions continue to improve, I anticipate that the Fed will announce further tapering in March, most likely to the $60 billion level. All in all, expect QE to continue throughout the year, albeit at the reduced total of $600 billion compared to $1.2 trillion in 2013.
Although the mainstream media has focused and indicated that market gains over the past few years have largely been driven by QE, I don’t believe this to be true. While easy monetary policy and asset purchases have certainly driven interest rates lower and helped put a floor under stock prices, it has been the improving economic environment, rising GDP growth, and strong corporate earnings that have been the principal causes of the market rise.
Heading into Q1 2014, my firm's favored sectors are the following: industrials, such as General Electric, The Boeing Company
(NYSE:BA), and United Parcel Services
(NYSE:UPS) and the small-cap health-care sector. We also believe consumer discretionary companies, which are well represented by the SPDR International Consumer Discretionary ETF
(NYSEARCA:IPD), will fare well.
Follow Oliver Pursche on Twitter: @opursche, and see Gary Goldberg Financial Services for more.
No positions in stocks mentioned.