Everyone wants to know where stocks are likely headed for 2014. Here are 10 cogent reasons why stocks are likely to keep going higher in 2014, even though scary volatility and freaky minor pullbacks (or even a mild correction) are also probable.
1) No budget stalemates or government shutdowns for two years. Congress agreed on two year budget deal thus eliminating the risk of failures to reach budget agreements causing government shutdowns with resulting fear and loathing in stock markets and disruptions in government services. Fiscal constraints or headwinds to economic expansion have been mitigated due to partial repeal of sequester cuts to government spending. Higher government spending, although a long-term problem, is a short to intermediate term stimulus to the economy. Refer to the below chart sourced from cbpp.org. 
2) No debt ceiling crises likely. After refusing to negotiate on the debt ceiling last time around and sticking to his word although under intense political fire, it has become increasingly clear that President Obama will not negotiate on the debt ceiling so there is nothing to be gained by Republicans trying to leverage the debt ceiling for negotiating changes such as repealing Obamacare or entitlement spending reforms. Also, Republicans suffered serious political damage from the last debt ceiling debacle and bellicose brinkmanship and government shutdown. So many ranking members of Congress, including Republicans, have promised they will not hold hostage the debt ceiling in an attempt to gain political leverage or extract political concessions. Thus Congress, particularly the House of Representatives, is quite unlikely to hold the debt ceiling hostage again. Refer to the below chart sourced from wikipedia.com. 
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3) Janet Yellen is astute and dovish. Ben Bernanke as head of the Federal Reserve will be handing off his chairmanship to Janet Yellen, whose nomination to be the new head of the Federal Reserve is extremely likely to be confirmed by Congress on January 6, 2014. Janet Yellen is widely considered to be a very intelligent and highly capable economist and leader of the Federal Reserve and FOMC. Janet Yellen is also considered, if anything, slightly to moderately more dovish than even Ben Bernanke was in terms of easy monetary policy. This makes it quite likely that the easy money policies of the Federal Reserve will continue unabated for the foreseeable future. Janet Yellen is a wise and capable replacement for Ben Bernanke and will continue his dovish monetary policies throughout 2014, while gradually tapering asset purchases. 
4) Even after $10 billion taper Fed still injecting much liquidity into economy. Although the federal reserve decided to taper its bond purchases or "quantitative easing" from $85 billion every month to "just" $75 billion each month, net-net this is still a very large amount of monetary stimulus coming into the economy to boost asset prices and make the banks $6 billion to $7 billion each year just on interest paid on their excess reserve deposits with the Fed. The banks are holding excess reserves approaching $3 trillion. The Fed of course only pays .25% on excess reserves so as to encourage most of these excess reserves and the $75 billion stimulus money (formally "bond purchases") to be invested or lent out by the banks at substantially higher interest rates thus making the banks even more money. Arguments have been made that the Fed should reduce the interest paid on excess reserves to maybe 0% or close to 0% so as to further incentivize investing and lending by the banks directly into the economy. In any event, this huge amount of liquidity sloshing around in the banks and economy results in asset prices being bid up which creates a wealth effect, which results in asset prices growing ever higher. This is a positive feedback loop for the economy, likely to continue at least through 2014. It's actually rather surprising that with all this excess liquidity sloshing around in the economy that our rates of inflation are still quite muted-this could change in 2014. Check out the following chart sourced from McClellan Financial. 
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5) Upward momentum likely to continue. Momentum in the stock markets is hugely important to gauge where the stock markets are likely to be going in the intermediate to longer term. I say intermediate to longer term because in the very short term it is anybody's guess where stocks will be going, as it becomes harder to accurately predict where stock prices will be going the further you zoom in on stock prices or the shorter the timeframe you are observing. It is actually quite similar to quantum mechanics in that sense. There are at least a couple adages that encapsulate this logic of the importance of stock price momentum. One old adage comes from Sir Isaac Newton who stated as a fundamental law of physics that, in essence, objects at rest tend to stay at rest and objects in motion tend to stay in motion and with the same direction and speed unless acted upon by an extraneous or unbalanced force. This means that, absent some exogenous force or shock such as a geopolitical event or a major news item or earnings report or et cetera, the momentum of any given stock is likely to continue in the same direction. A second old adage in confirmation of the importance of analyzing stock price momentum is that "the trend is your friend until the end". Being able to discern "the end" of the trend is very important, and many books have been written on the subject of knowing when to sell, but the main idea is that you should stick with the trend of stock price movement instead of fighting the trend as, all things equal, the price movement is more likely to remain consistent with the trend than to move countertrend. In the case of the present stock market (in the United States at least), it is likely the upward trend will continue. See this chart sourced from BigCharts. 
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6) Corporate earnings to continue to grow at record breaking levels. Corporate earnings are at record-breaking profit levels and are projected to be about $118 per share for the S&P 500, which equates to about a 12% earnings growth rate year-over-year. Corporations are doing more with less through very astute management. Also, technology has a lot to do with record corporate earnings, as computers and robots are increasingly doing more of the work that humans formerly had to do. And although computers and robots are a larger up-front expenditure, over the life-span they save much more money than having to pay humans to do the grunt-work. And computers and robots do not require workers compensation insurance, disability insurance, medical insurance, Medicare and social security insurance, etc., thus resulting in substantial unit labor cost savings for these corporations. These technological innovations also have the added side-benefit of lowering the costs of products people buy every day such as cars and computers. When humankind innovates to the point where robots are more or less independently able to make more robots and computers then we will enter a golden-age of prosperity where humans will have increasing standards of living while also, paradoxically under conventional wisdom, having higher rates of unemployment. Refer to the S&P Capital IQ chart below. 
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7) ZIRP Fed policy will stay in place throughout 2014. Zero interest rate policy ("ZIRP") of ultra-low long term interest rates will remain in place through 2014, giving a boost to economic growth. Also, if companies and banks can only earn low interest in United States' treasury notes then they are instead likely to seek higher yield through increased lending and credit expansion. For example, the banks are only making .25% interest on excess reserves from the Federal Reserve, so as long as the economy appears to be strong and growing, banks are likely to take their three trillion in excess reserves and instead loan this money out at higher interest rates in the form of car loans and mortgages and other types of loans, resulting in more consumer spending and the multiplying effect as the velocity of money increases within the economy. Check out the below chart sourced from wallstreetexaminer.com. 
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8) The great rotation is likely to accelerate. The so-called "great rotation" is likely to finally accelerate as higher interest rates on 10 year, 20 year, and 30 year treasuries will cause bond prices to trend downward, making bonds a less attractive investment and correlatively making equities a more attractive investment. Also investors are likely to rotate out of commodities and into equities as commodities have been performing very poorly of late. The term TINA, or "there is no alternative", will continue to be bandied about by market analysts and pundits as aptly describing the equity markets as being the best place to be in terms of highest rates of return-even though risk adjusted return is a whole different ballgame and risk should always be kept in mind when evaluating potential investment opportunities. In fact, you should constantly be asking yourself "Am I being adequately compensated via the equity risk premium for the risks I am incurring the market?" I believe this much ballyhooed great rotation into equities will likely accelerate in 2014 and support and boost equity pricing in 2014. We could also see some multiple expansion of the P/E ratio, boosting equity prices further. Also important to note, the current allocation to equities of 53% is below the benchmark of 65%. Check out this chart sourced from EPFR global. 
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9) Consumer spending and consumer sentiment are improving. Consumer spending drives two-thirds of gross domestic economic growth and consumer spending is increasing, and consumer sentiment polling data is also markedly improving. For example, the latest steady and solid consumer sentiment reading of 82.5 in December 2013 is substantially improved from November's reading of 75, but more importantly consumer sentiment readings have been trending upward since the lows of around 55 back in late 2008 and early 2009 in the depths of the Great Recession, which some are now calling a Depression. One area of concern is that wages have not been increasing as much as consumer spending has been increasing, which results in an increasing net amount of debt held by consumers, which is what got us into the giant mess we were in during the mortgage-housing-financial crisis. Nevertheless, this point in time in the consumer and business cycle is unlikely to see a recession in 2014. See the chart below sourced from tradingeconomics.com. 
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10 Unemployment rate continues to trend downward. The last but certainly not least of my 10 reasons why 2014 will likely continue seeing gains in the stock market is that the unemployment rate continues to trend lower. In fact, from an unemployment rate that peaked at 10.8% back in the worst depths of the Great Recession, the unemployment rate of 7% as of the latest readings in November looks much better and appears to be gradually trending downward as the economic recovery picks up steam. One area of concern is that whilst the unemployment rate goes down the labor force participation rate is similarly going down, such that one could argue most of the decline in the unemployment rate is simply due to the declining labor force participation rate. In fact, bears argue that the latest reading of the actual unemployment rate (known among economists as U-6) as of November 2013 is 13.2% when seasonally adjusted, as compared to the much lower 7% official figure (known among economists as U-3). So, when digging down a bit deeper, the labor picture is not as rosy as it might otherwise officially appear. See the chart below sourced from tradingeconomics.com. 
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On balance, all things considered, our analysis and models indicate that the S&P 500 will likely go up around 10%-15% during 2014, with fits and starts. Breaking down our analysis with greater granularity, barring some large unforeseen geopolitical crises or conflict or the like, the likelihood of a 10%-15% increase in the S&P 500 for 2014 is 50%. The likelihood of a 15%-20% increase is 20%. The likelihood of a greater than 20% increase is 10%. The likelihood of a 0% to 10% increase is 15%. The likelihood of a negative year is only 5% considering we are in the middle innings of an expansionary time in the business cycle as explained by the bullish factors above. Be prepared for increased volatility however, as it is quite unlikely that 2014 will be as good a year as 2013, where the bad news events never got that bad and the fears were never realized and no correction occurred and a pullback of 4-5% was considered really scary. In fact, we have not seen a 10% or greater correction in over two years. Judging by historical averages and the reversion-to-mean effect, there is a substantial likelihood of a 10% or slightly greater correction in the markets at some time during 2014, so stay flexible and closely monitor your positions if you're a trader. If you are a very long-term buy and hold investor, an advantage is you need not worry too much about pullbacks or minor corrections, you can just worry about macro-trend bull and bear markets. Here's wishing you a Merry Christmas and Happy New Year of successful trading or investing!
Disclosure: I am long GNW. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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