A combination of weak earnings, deflation across the Eurozone and panic selling throughout emerging markets led to the worst January performance for U.S. equities since 2010. To say I am pleased I sold a substantial portion of stock portfolios for clients on Jan. 2 is a gross understatement.
Last month we witnessed a dramatic reversal in the positive trend stock markets have enjoyed for the better part of the past five-plus years. From the March 2009 low of 666 on the Standard & Poor’s 500, with very few significant dips, stocks appreciated by a mind-blowing 178 percent through the end of 2013. Since then, however, we have seen the S&P 500 slip by 3.6 percent.
There is some statistical support for the premise that years that begin with negative January stock performance end up being down years overall for stocks. While I would agree that investor sentiment has been negatively affected by the losses incurred in January, I believe there is ample strength in the economic indicators to support a positive follow-on year for stock performance. (See my Dec. 22 column, What Investors Should Expect in 2014, for more on how stocks have performed historically after years with strong double-digit performance.)
Last week, the preliminary GDP report for the fourth quarter of 2013 showed annualized growth of 3.2 percent. Third-quarter 2013 GDP growth was revised up to a 4.1 percent annualized rate, as well. Although this report was not enough to stem the overwhelming tide of negativity surrounding earnings, Eurozone deflation and emerging market problems, it was a solid indicator that the U.S. economy continues to build momentum, although the pace of that momentum is still unimpressive.
Argentina’s devaluation of its peso by 11 percent shocked markets. Still more concerning is the fact that Argentina’s government has been deficit spending to try to shore up its economy, which helped drive inflation to an estimated 28 percent last year, the highest in more than two decades. In addition, the government’s use of price controls and rampant nationalization of companies without compensating owners has led to a mass exodus of foreign investment capital. As a result, the government has been forced to spend billions of its dollar reserves in an attempt to support Argentina’s currency, reducing reserves to an estimated $29 billion, or by about $15 billion in 2013 alone.
Although the recent devaluation was shocking, it is very likely that these dollars will devalue by an additional 50 percent or more before the end of 2014. As a direct result of the turmoil in Argentina, investors have begun to exit emerging market investments en masse, which has also driven selling in U.S. markets.
As a new month begins, U.S. investors are pondering their options. After last year’s explosive gains for stocks — 30 percent for the S&P 500 — many investors have significant realized capital gains. As tax time fast approaches, many of these investors will need to sell positions to raise cash for their tax bill. Should they sell now and risk missing a rebound rally, the response that U.S. stock investors have grown so accustomed to experiencing over the past few years, anytime stocks dip? Or should they risk waiting until later in the year, closer to April 15, and risk a more significant correction occurring in stocks that could push the market down by 10 percent, 15 percent or even 20 percent from the recent highs? We certainly can’t rely on the Super Bowl indicator, which projects positive stock market performance should one of the original NFL teams win. Neither the Denver Broncos nor the Seattle Seahawks are original members.
This week will be critical to determining which direction stocks will take. If we see a strong rebound rally this week, and especially if the S&P 500 can weather the storm, remaining above the key support level of 1,775, investors should gain some confidence.
That confidence could translate to stocks moving back up to recent highs and possibly even a new all-time high. However, if we see continued selling this week, and especially if the S&P 500 breaks down through 1,775, we should expect to see stocks continue their slide. In this case, a correction of at least 10 percent from the 1,850 level, or down to about 1,665 or so, will be highly likely.
Long-term investors should not fear this correction, however, since economic factors look to continue to improve over the course of this year and beyond. I would view any significant correction as a strong buying opportunity, as stocks still appear to be the most attractive asset class in comparison to bonds, real estate, commodities, etc.
I expect to see the S&P 500 push up to between 1,900 and 2,000 by year-end. This upside potential, coupled with a chance to buy stocks coming out of a significant correction, perhaps as low as the high 1,500s/low 1,600s should provide the best opportunity for investors that they will see in 2014.