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by Steve Reitmeister Published on January 03, 2014

2014 Stock Market Outlook

No matter how you slice it, 2013 was a terrif ic year f or stock investors. The +32% return f orthe S&P 500 was the third best showing since 1970. However, this success breeds two verydif f erent responses f rom investors as they look out at the new year.

1) Elation that the good times will continue.

Vs.

2) Fear that it has been too good and now we are due f or a f all.

In this article I will review the investment landscape f or the year ahead. This will include a target price f or theS&P 500 along with some potential pitf alls.

Historically Speaking

The statistics below should tell you a clear story that there is no benef it or harm the year f ollowing a bigrally year like we had in 2013. Simply it states that each year is unique and will move up or down based uponthe f actors going on at that t ime.

So What Are the Unique Factors in 2014?

The economic picture continues to improve as GDP growth is accelerating f rom the previous MuddleThrough pace of just 1-2% growth. So right now there is no threat of a recession, which is Public Enemy #1f or stocks.

The main issue at this stage revolves around valuation. Those who point to a historical average PE of 15say the market is f ully valued at this t ime given expected S&P 500 earnings per share of $120 this year.

This is a short-sighted view. First, that 15 average PE concept goes back too f ar in t ime when investors didnot properly appreciate the risk/reward relationship of stocks versus bonds. Since then 16-17 PE has beenmore the norm.

Second, a maturing bull market will always have higher valuations than average. That is the dif f erencebetween f air value and f ully valued.

Third, valuation is also about the attractiveness of stocks versus other investment alternatives. Cashcontinues to be trash with ultra- low interest rates. Bond f unds are losing money as rates go higher. Realestate has stalled out (also thanks to higher rates). Gold is going nowhere. And please let's not waste ourtime talking about bitcoins.

Add it all up and this points to another year of gains f or stocks.

2014 Prediction & Potential Pitfalls

The S&P is up 53% the past two years and +177% since March 2009. Thus, the easy money has beenmade and we should not expect such robust returns in 2014.

More likely stocks will provide a more modest gain of +8 to 10%. That would create a target range of 2000to 2040 on the S&P, which is a f ully valued market around 17 times current year earnings estimates.

What would prevent this from happening?

Three hazards are out there:

1) Recession: Above I shared with you that the economic landscape is actually improving. However, theaverage expansion period between recessions lasts f or 63 months. If that held true here we would see thenext recession starting in the 2nd half of 2014.

Gladly this does not happen like clockwork. Each expansion is unique and this one seems to have plenty oflif e lef t in it. Yet, if the next contraction does start to appear, then the route to prof its is by shorting themarket.

2) Treasury Bond Rates: There is a historical relationship between Treasury bonds and the stock market.And that would be an Earnings Yield that is 3% above the Treasury 10 year rate. Right now that rate is 3% +3% premium f or stocks = 6% Earnings Yield. This implies a PE of 16.7 is f air value f or stocks.

I believe stocks will do f ine if rates f loat up to around 3.5%. Above that and it will start to call into questiontheir relative value versus bonds, which could spark a correction.

3) Volatility: The gains in 2013 came all too easily. Each correction was shallow and short lived. I suspectwe will see a bit more volatility in 2014 and those that spend too much ef f ort t iming the market will likely getchopped to pieces. Likely it will prove best to just stay the course with the best long posit ions and don'tsweat the temporary downturns that come our way.