Why 2014 Should Be Another Great Year for Stocks

Feb. 6, 2014— -- After the U.S. stock market’s strong performance in 2013, the question on everyone’s mind is: Will the pendulum swing back this year? In January, the Dow Jones Industrial average tumbled 5 percent, and the first part of February hasn’t been kind to stocks either. A rocky start to the year has prompted pessimists to wonder what other hammerings might be in store this year.

So it’s probably unfashionable to say this, especially after the market meltdown of 2008–09, but I expect 2013’s rise to continue. I believe the Dow will hit 20,000 by 2015 — and possibly this year. With the Dow having risen about 27 percent in 2013 (the greatest one-year increase in 18 years), many people might dismiss this rosy projection as being right out of Never Never Land. But a strong case can be made for it. If current economic conditions and history is any guide, the market is likely to continue upward into 2015, contrary to doom-saying by those reacting with knee-jerk fear to January and more recent down days.

The case for a robust 2014-2015 includes these points:

• Strong corporate gross profit margins of 29 percent drove robust earnings last year, and margins are forecast to be up even more in 2014, to more than 34 percent. Gross margin is simply a measure of profitability--the higher this figure, the more a company adds to its bottom line with each dollar of sales. In 2014, all signs are that margins will be strong and with them, new investment.

• Economy rising. One reason for healthy margin and earnings is the lighter load that many companies are carrying now that they have macroeconomic winds at their back. During and after the Great Recession, these companies were able to throw a lot of garbage off their corporate buses. Now they’re leaner and meaner as a result, and better able to profit from rising consumer confidence that will prompt large companies to part with some of their trillions in cash reserves, thus stimulating the economy and purchasing.

Consumers, who are reversing their recessionary mentality that they would have to eat gruel for a decade, continue to go to work every day. And though many of them may not have had a raise in years, they no longer see a hangman’s layoff noose every time they walk past HR. Also, they once again are experiencing the wealth effect because their homes are again rising in value. So more are breaking down and buying that new car they’ve been postponing.

• Rising employment will continue. Technological innovation won’t just eliminate jobs; the productivity it generates will seed new jobs in various economic sectors. Sustained earnings will spur share-price growth. That, plus the current doldrums in bonds, will speed the reversal of the Great Rotation from stocks to bonds and alternative investments (made fashionable by big university endowments, which were widely imitated).

• High earnings will accelerate this counter-rotation back into stocks. We had a stellar market in 2013 despite all predictions to the contrary: that the comeback of 2010–2012 could only lead to another crash and that many foreign economies had tanked — along with negativity stemming from the federal budget sequester, the government shutdown, Congress’ balking at raising the debt ceiling and the disruption in the Japanese industry and exports caused by the tsunami. Analysts from prestigious institutions incorrectly read these tea leaves as pointing to low-single-digit returns at best in 2012–2013. Now that economic forecasts are more optimistic, does it make sense to rule out a robust Dow in 2014–2015?

• Tapering, schmapering. One reason so much fear has stemmed from the market’s early 2014 performance is the Federal Reserve’s tapering of economic stimulus. The widely held view is that the market was hooked on this stimulus and that taking it away would send the market into cold turkey. But the tapering is really no big deal. The market may have been hooked, but the real addiction was to the belief that the stimulus was actually stimulating the economy.

However, much of the money from the Fed’s bond purchases has ended up in (where else?) banks. The combination of low money velocity (the rate at which money is exchanged) and the low lending activity of these banks has meant that little of the cash generated by the Fed stimulus has made it into the general economy. So the Fed’s tapering of this stimulus isn’t the dire development that the Chicken Littles out there insist. Because there’s a fine line, if any, between perception and reality in the market, the Fed’s tapering may depress investment a bit for a time, but the economy is what it is, and unrelated factors that have actually been driving growth will remain in force.

• The past as prologue. The S&P 500 rose about 32 percent in 2013. Since 1975, the S&P 500 has risen more than 25 percent in a year 10 previous times. In the two-year periods ensuing after those 10 times, the index posted a total return averaging 26 percent (per two-year period). A repeat of this average total increase in the S&P 500 over the next two years would mean a Dow over 20,000 in 2015.

• Corrections as a fact of market life. Investors shell-shocked from 2008–09 view 2013 market performance with jaundice, grimacing in anticipation of a painful correction. It’s true that corrections are inevitable. Historically, one has occurred nearly every year, but fearing corrections is like saying that forest fires (not started by campers) are unnatural. Both are a natural phenomenon leading to regeneration. Market corrections ratchet things back, lowering values and increasing the perception of risk, but this increases expected returns. Sure, the market ascendance of the last year suggests a likely correction, but with prices lagging behind earnings and corporate investment likely to increase to exploit rising consumer confidence, a strong comeback from any correction is likely.

Those who view a 20,000 Dow by 2015 is wildly optimistic should look at long-term market history and current economic data -- and then look forward again. Can they make a case for a sustained depressed average Dow over the next year or two that isn’t based on irrational non-exuberance (scars from 2008–09) or correction-o-phobia? If so, what is it based on?

The stock market is a mercurial, unpredictable force. After a long run-up, it is just as likely to continue to rise as it is to fall.

Dave Sheaff Gilreath is a founding principal of Sheaff Brock Investment Advisors LLC. He has more than 30 years of experience in the financial services industry, beginning with Bache Halsey Stuart Shields and later Morgan Stanley/Dean Witter. At Sheaff Brock, he shares responsibility for setting investment policy, asset allocation and security selection for the company's managed accounts. He also consults with the clients on portfolio construction. Gilreath received his Certified Financial Planner® (CFP) designation in 1984. He attended Miami University in Oxford, Ohio, where he earned a B.S. degree.