Friday, December 13, 2013

Is Wall Street Overly Bullish on 2014?

According to Business Insider, Wall Street consensus expects the SPX to rise another 10% in 2014, to 1950 (the mean as well as the median estimate). Read the article here.

Here are their YE 2014 forecasts (EPS in parentheses):

Barron's ran a similar survey this weekend. The consensus among ten strategists was a rise to SPX 1980 (+12%). See their picks here.

Is this realistic? The short answer is probably not.

Some background first.

Secular Bull Markets

In the last 115 years, there have been three 'secular' bull markets. Secular bull markets are generational in length. The most recent ran 18 years, from 1982 until the 2000 tech bubble burst. The post-war bull market ran 17 years. The major lows were in 1915, 1942 and 1974.

Many believe that 2009 was also a generational low. It fits the pattern. If this is the case, there is a long secular bull market ahead. These have gained over 500%, so there is likely a lot of gains ahead.

Cyclical Bull Markets

Secular bull markets are distinct from 'cyclical' bull markets. Think of each secular trend as being divided into several cyclical trends. The classic definition is a rise or fall of 20% (daily close) to delineate each cyclical bull market from the cyclical bear market in between.

While each secular bull market is about 17-18 years in length, each cyclical bull market typically lasts 4 years. Secular bull markets gain over 500%; cyclical bull markets gain about 100%.

Below is a list of the cyclical trends since 1929. The colors correspond to each decade; you can immediately see that trends were short in the 1930s and have been longer ever since. The mean and median are therefore calculated from 1940 onwards.

The current cyclical bull market (58 months) is the sixth longest and about 10 months longer than typical. The bull markets of the 1980s and 2000s were only 3 months longer than the current one.

The current cyclical bull market has gained 167%, about twice the median and the fourth largest overall, surpassed by only the post-war, 1980s and 1990s bull markets.

In summary, the markets enter 2014 with duration and gains already well over what is typical and among the longest/strongest on record.

What To Expect After A Generational Low

Assuming this is near the start of a new secular trend that lasts past 2020, how will this unfold?

One pattern that stands out is that after every generational low (1915, 1942, 1974), markets advanced strongly and then consolidated within 5 years: 1946-49 and 1977-80, for example. The table below shows the generational lows (green) and the yellow shading reflects these 'consolidation years'.

You can see that there was a cyclical bear market within 6 years of every generational low as well: 1917, 1946, 1948 and 1980.

This, in fact, is common not just at the start of secular trends but also among cyclical trends.

What To Expect After A 5-Year Bull Trend

2013 is the fifth year in a row where the Dow has gained more than 5%. In the past 115 years, the Dow has never gained more than 5% six years in a row. Moreover, even a 5-year bull trend has only happened once before - the 1990s - and that was followed by three down years. There were two 4-year bull trends (1942-45 and 1949-52), each followed by a down year.

4 Year Presidential Cycle

2014 is also a mid-term election year, the weakest year of the four year Presidential cycle. On average, these years are flat. In comparison, according to Ned Davis, the following two years gain an average of 60% combined. It is typically the year that refreshes.

The last 4 mid-term years all traded lower from the January open by May, bottoming between July and October.

According to Stock Traders Almanac, mid-term years following very strong years like 2013 average gains of just 2%.


So is Wall Street too optimistic in expecting a sixth year of gains of 10% in 2014? History is not on their side. This doesn't necessarily mean that a cyclical bear market is imminent, although at 58 months the current bull market is likely in the late innings. The fact that its also a mid-term election year also raises the odds that it will be a low growth year.

A period of consolidation, like 1953, 1984, 1994, 2004-05, is probably a more realistic assumption. It is also, based on the consensus forecasts above, completely unexpected; only one of those 14 banks expects anything less than 1900 next year.