Wall Street bulls say the good times can continue in 2014. But despite articulately laying out a bullish case for stocks, they also admit that there are risks to their upbeat forecasts.
Here are five things that could go wrong next year, and trigger the first sizable correction since late 2011.
A repeat of last year's eye-popping 25% to 40% returns in 2014, market strategists warn, could potentially spawn a 2000-style stock market bubble that could trigger a market decline far worse than a garden-variety 10% correction.
"Melt-ups are fun when they are happening, but they tend to end in much bigger corrections," says Liz Ann Sonders, chief investment officer at Charles Schwab.
Wall Street prefers a steady rise in prices from current levels, with gains in the 5% to 10% range, so prices don't get disconnected from earnings, says David Kelly, chief global strategist for JPMorgan Funds.
The reason: The melt-up scenario, which could be driven by a mountain of cash arriving late to the stock market party or a stimulus-fed bubble, will likely turn a market now considered "fairly valued" into overvalued territory.
"Be careful what you wish for," Kelly says.
Investors have become addicted to stimulus. Although Wall Street in December took news of the start of the Federal Reserve's exit from its bond-buying program in stride, expect more "taper tantrums" in 2014, says Ann Miletti, senior portfolio manager at Wells Fargo Advantage Funds.
"Maybe the Fed executes perfectly and it doesn't create a lot of waves," Miletti says. "But I would anticipate a withdrawal period. Interest rates won't stay ultra-low forever. In the long run, the economy not needing as much stimulus is a good thing. But there will be disruptions along the way. But we would be buyers at lower entry points because we believe in the longer-run story."
If first-day IPO price pops and the Dow's stunning rise garner more water-cooler chat time than, say, the first outdoor Super Bowl in wintry New York or Beyoncé's latest hit, watch out. It could signal that bullishness has gone mainstream, and irrational exuberance is back. Everyone knows what happens when everyone thinks stocks or home prices can't go down.
The market is not at an optimistic sentiment extreme yet, Sonders says. Individual investors are just now starting to funnel money back into the stock market after withdrawing cash for five years. Bullishness on Main Street, while rising, is far from prior peaks. Institutional investors such as hedge funds also remain underinvested in stocks.
But investor sentiment bears watching. "If you got to an extreme in bullish sentiment, you could point to that solely as a reason for the market to consolidate its gains," Sonders says.
If CEOs are unwilling to go on the offensive and start deploying more of the $1.2 trillion in cash sitting on their balance sheets, it could take away a key plank of the economic growth story. "The key question is, what are they going to do with all that cash?" says Terry Sandven, chief equity strategist at US Bank Wealth Management.
If CEOs remain tight-fisted, it means fewer jobs, less spending on tech upgrades, fewer new plant openings and less M&A activity. In short, less spending means less economic growth.
Wall Street is betting on faster growth, perhaps a return to 3% GDP.
But faster growth isn't assured, given that interest rates are rising. If global growth doesn't materialize, the bull case weakens, says Marty Sass, CEO of money manager M.D. Sass. If a market storm occurs in 2014, it'll likely result from a "growth scare," warns Jeffrey Kleintop, LPL Financial chief market strategist.
By Adam Shell
RISK NO. 1
A MARKET 'MELT-UP'
RISK NO. 2
A MESSY FED 'QE' EXIT
RISK NO. 3
A RETURN OF IRRATIONAL EXUBERANCE
RISK NO. 4
A 'DEFENSIVE' CLASS OF CEOs
RISK NO. 5
A 'GROWTH SCARE'
Copyright 2014 USA TODAY
Original headline: 5 risks that could derail bull market
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