Tea Leaves and Crystal Balls

Given that the New Year is just around the corner, brace yourself for a barrage of Wall Street predictions. Investors love to read them, despite the fact that the vast majority of forecasts will be proven wrong. Last year, I was lucky and spot on with my bullish forecast, but 2014 could be different. First, the good news, the economy and employment will continue to grow.

Despite the naysayers, the quantitative easing by the Federal Reserve Bank over the past several years was, in my opinion, a success. In 2013, we began to see the fruits of their labors. I believe the strength of the stock market this year was fueled by the gathering strength of the economy and not by what the Fed would or would not do.

Unemployment will continue to fall and will drop to below 6.5 percent by the end of 2014. The strength of the economy will mean an increase in hiring by the nation's businesses and corporations. Wages will begin to climb for workers and profits will expand among employers.

As a result, the stock market will continue to make gains, although not at the pace of 2013. Declines this year were short and shallow. Every time the markets dipped, buyers took that opportunity to add to their holdings. The S&P 500 Index made it through the year without once experiencing a 10% decline. The dazzling strength of the stock market disappointed those who were waiting for a serious pullback before entering the market. It won't happen like that in 2014.

I suspect that somewhere at the end of the first quarter or into the second quarter, we will see a substantial stock market decline of the 15-20 percent variety. Now, folks, this will not be the end of the world nor should you treat it as such. It will simply be a much-needed correction within a bull market. The second year in an election cycle has always been a bad one for stocks, and there is a lot riding on elections in 2014. At the same time, if markets continue to advance, valuations will become stretched and the chances of a big sell-off will grow higher and higher.

Interest rates will also continue to climb in 2014. This year was the turning point for bond investors. The thirty year bull market in bonds is over and the next several years will see declining values in bond portfolios and higher and higher interest rates. It may well be that as the Fed begins to taper in earnest next year; interest rates could climb high enough to spook the stock market, causing the sharp selloff.

The good news is that I expect all the potential losses that stock investors would incur under my 2014 scenario could well be made up by the end of next year. It may well be that the market's 2014 gains could be around the historical norm, about 7 percent, when all is said and done. As most of my readers and clients know, I will not sit idly by in the face of such a selloff, if it should occur. Unlike this year, where my strategy was to buy and hold, next year will require a certain amount of adeptness in first selling and then buying back equities for some of you. For those longer-term players who are willing to do nothing, you can expect, at worst, some paper losses that will be made up by year-end.

Remember too, that we are in a secular bull market. As such, next year's decline, if it occurs, would be merely a speed bump in the grand scheme of things. I fully expect the stock market to continue to make gains beyond 2014, possibly as high as another 60-80 percent. So the best New Year's resolution you could make in 2014 is to stay with stocks for the foreseeable future.

Bill Schmick is registered as an investment advisor representative and portfolio manager with Berkshire Money Management.


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