"After five years of moving from crisis to crisis, 2013 was less volatile and the near-term forecast is for continued smoother skies. The U.S. government is unlikely to be shut down, the Fed's QE tapering has begun, the European debt crisis has eased substantially, banks have repaired their balance sheets, and even tensions in the Middle East have come off the boil. There remain risks, but the drama associated with many of these events has noticeably declined. But, does that mean smooth sailing for stocks?
Not necessarily. We still remain optimistic that 2014 will end up being a positive one for equities, and history backs this up, as gains such as we saw in 2013 (more than 25%) are usually followed by decent advances the following year. However, we often comment how equities like to climb a "Wall of Worry" as evidenced by last year's steady and strong advance, despite some drama that could have derailed stocks. But the strong market returns have softened that worry and complacency could be a near-term hurdle for stocks. Investor surveys are indicating that sentiment has become a bit frothy and we are watching for more clear danger signs if gains continue. We can't forecast or time corrections any better than others; while last year taught investors about waiting on the sidelines for one to occur. We also know from history, that although midterm election years have often brought nasty corrections, they were also typically followed by robust returns over the subsequent couple of years. We do believe if a correction unfolds early in the year, it's more likely a buying opportunity than a sinister sign for the year and beyond".
Improvements continue
"We would likely view a decent sized pullback as a relatively healthy pause in an ongoing secular bull market and would caution against trying to time around it. Our optimism is rooted in several key themes, including: an improving U.S. economy, a likely healthy earnings season, a still-extremely accommodative Fed, reduced fiscal drag, stabilizing global economic growth, and outsized corporate cash balances that we believe will feed into better capital spending this year.
With less drama, but more complacency, earnings season may take on added importance, especially forward-looking guidance by corporate leaders. Heading into fourth quarter earnings reporting season, expectations were relatively muted and it wouldn't be a surprise to see lowered estimates beaten at a higher-than-average rate. Given how much valuation has expanded over the past two years, earnings will likely have to shoulder more of the market's heavy-lifting this year.
Economic growth may be gaining some traction after years of "new normal," sub-par growth The Institute for Supply Management's (ISM) Manufacturing Index posted a solid 57 reading for December, continuing the string of strong readings. Its employment component rose to 56.5, the highest reading since June 2011, while new orders were impressive at 64.2. We pay special attention to this last reading as it has tended to have a high correlation with both capital spending (as you can see in the chart below) and bottom-line earnings growth".
