Mostly Sunny in 2014, With a Chance of Heavy Rain

 | Dec 31, 2013 | 12:30 PM EST  | Comments
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jpm

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FB

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twtr

It's that time of year -- when we pundits are expected to say something interesting and shocking about what's to come, and when we're supposed to make bold predictions for the next 12 months. Well, I'm sorry to disappoint you, but when I look at the year as a whole, my view is boringly in line with consensus.

It is hard to escape the notion that 2014 will see continued gradual economic improvement and a resultant increase in corporate profit. The market is bound to reflect this, but two factors will prevent another 30% gain in the coming year. Firstly, the Federal Reserve stands to cease adding fuel to the fire, and it's likely to gradually reduce financial stimulus throughout the year. Second, there is less room for expansion in the price-to-earnings multiple. The overall P/E ratio for the S&P 500 is close to its historical average, and traders and investors are only too familiar with what a bubble looks like, so I would expect some caution from the current juncture.

Of course, if stocks rise by, say, 10% to 15%, that doesn't mean the gains will be evenly spread among sectors and occur in an orderly fashion throughout the year. There will be peaks and troughs, and some sectors will outperform others.

On the positive side, as I said in these pages a couple of weeks ago, I feel "alternative" energy will do better than will conventional oil and gas next year. In fact, I feel so strongly about this that I risked upsetting a new audience when I made the point on my first appearance on "The Trader's Network," a Dallas-area radio show.

I would also make a case that financial stocks are bound to have a better year than most in 2014. While the mega banks will have to survive even as the Fed hands them less cash each month, modest climbs in interest rates will make lending more profitable, and any uncertainty regarding regulation is over now that we (and the banks themselves) know more about the contents and structure of the Dodd-Frank law and its "Volker Rule" regulations. This is one area in which there's room for some multiple expansion, as well as the prospect of earnings increases. So I like big banks for 2014, most notably Bank of America (BAC) and JPMorgan Chase (JPM).

Although I believe the market will finish the coming year with positive returns, history tells us they won't come in a straight line. At some point we will see a significant drop in markets, though it would really be guesswork to predict what will cause that. That said, as we head into the new year, there are two areas that worry me: Europe and social media.

European stocks have been roaring in the second half of 2013 and, if you listen to a lot of the chatter, you could be forgiven for believing that everything there is fine and dandy. Well -- it's not. Unemployment levels in both Greece and Spain are still above 25%, and both governments are struggling with huge per-capita debt. Further, there is still friction between the two most powerful nations in the group, Germany and France. In short, it is hard to escape the feeling that, once again, bad news from the Old World could derail things at some point next year. As a foreign-exchange guy, I for one will keep a watchful eye on the euro.

Social-media stocks could also provide a jolt. While stocks in general look fairly valued with little sign of a bubble, the same can't be said of emerging social-media companies. Facebook (FB) has been enormously successful and will likely continue to be so, but it's a mistake to believe every company in the same field will do the same -- and such assumptions have led to some ridiculous valuations. I mean, look at Snapchat: This is a company that has never brought in a dollar in revenue, and yet it has turned down offers in excess of $3 billion for the company. Something smells here.

Twitter (TWTR) has surprised many, myself included, since the initial public offering. But the fact remains that the company has never made a profit. Until Twitter shows that it can monetize its popularity -- especially given the short attention span of its users -- and do so while controlling costs, a market capitalization of more than $30 billion looks rich to me. At these levels, share-price volatility is exaggerated, as we have seen over the last couple of days, so any hint of bad news could trigger a significant selloff.

I fully expect 2014 to be a decent year for stock investors when taken as a whole, but it could be a rough ride. Clean energy and financials should provide opportunity, and I'll be closely monitoring the euro and social-media stocks for any signs of weakness. You should do the same.

Happy New Year to one and all!

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