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Be Watchful of the World, Selective With Your Stocks in 2014

Better conditions for the market isn't a reason to lower your guard

   

2013 was a spectacular year for the market, with the S&P 500 rising 30% to all-time highs above 1,800. It’s not going very far out on a limb to say that 2014 won’t be as strong as the Fed reduces quantitative easing and interest rates rise.

That said, I do expect the market will be up this year.

I wouldn’t be surprised to see the S&P 500 around 1950 by the end of 2014, which would be a solid 6% to 7% gain in line with historical averages. That would be a reasonable 16 times earnings of $120 per share from S&P 500 companies.

I do think we could see a correction early this year as the Fed begins to taper, and we also are long overdue for one. Investors would be smart to have enough cash on hand to take advantage of a correction to buy stocks at lower prices.

As you would expect, the Fed’s goal of lowering the unemployment rate will remain in focus in 2014. The trend was positive in 2013, but one thing you don’t hear much about that bears watching is declining participation among the labor force. Demographics will create a scenario where fewer Americans are working, and outsourcing as well as heavy pension burdens will put pressure on economic growth.

It’s a pretty sure bet that interest rates will rise as the Fed tapers QE, but I look for the market to regain its footing as long-term rates won’t increase enough to kill the bull. I look for yields on 10-year Treasury bonds to not move much higher than 3.5%, as we’re still facing considerable deflationary pressures and risks to the global economy.

On the positive side, oil prices should continue to decline thanks to more supply from the U.S. and easing political tensions (for now).

Globally, China will remain very important. It always is, but right now we need to watch that country’s transition to a more consumer-oriented economy. This will not be easy, especially with the government restricting lending. The intent is to keep property prices from running away, but less lending also keeps a lid on growth.

We can’t forget about our old friend, Europe, either. Thankfully, the debt crisis isn’t dominating the headlines the way it used to, but don’t assume it will stay that way. A big risk in Europe right now is deflation (lower prices for goods and services). Both money supply and wholesale prices have dropped in recent months. Combined with the end of QE, this could raise concerns of — are you ready for it? — a debt crisis. Deflation makes it harder to repay debt because incomes and asset values are less.

I’m not saying we’re in for a repeat performance of a couple of years ago, but investors would be smart to stay on top of Europe’s economic health.

All in all, I expect a positive year for stocks, but I expect the market to become more selective. Many of 2013’s high-fliers now carry lofty valuations — Starbucks (SBUX) and Nike (NKE), for example — and those valuations could become vulnerable as interest rates rise.

Hilary Kramer may hold some of the aforementioned securities in her GameChangers, Breakout Stocks Under $10 and High Octane Trader portfolios.

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