Market Forecasts of 2013 and 2014 By: Gabriel PotterMBA, AIFA® 2014.01.20
Revisiting the Predictions for 2013

The predictions for 2013 regarding government policy, interest rates, inflation and growth estimates were roughly accurate.  Despite the drama on Capitol Hill, financial regulation and the - albeit messy - implementation of the Affordable Care Act moved forward.  Short term rates barely moved and inflation was well contained.  Growth rates were commensurate to the 2% to 3% range suggested by economists. In short, the fundamentals surrounding the economy were predicated on slow, uninspiring growth and no outlying event pushed the economy in a drastically unforeseen way.

Market Targets from January 2013

Despite the consensus of market analysts and economists predicting a lot of the fundamental factors correctly, the equity market returns for 2013 were grossly underestimated by nearly everyone. As a reminder, here were the initial S&P 500 targets for 2013 which we presented a year ago.

Institution

S&P Forecast for 2013

Ending Value, Dec 31 2012

1426

Credit Suisse

1550

Federated Investors

1660

Barclay's Capital

1525

Putnam Investments

1490

BlackRock

1545

Goldman Sachs

1575

JP Morgan

1580

Citigroup

1615

Morgan Stanley

1434

Prudential

1600

Bank of America / Merrill Lynch

1600


The actual closing value of the S&P 500 was 1848.  Based on the averaged forecast, the predicted rate of return was about 9.5%.  In actuality, the price return was about 29.6%.  Once you factor in dividend payments into the calculation, the total yearly return of the S&P 500 works 32.4%.

So, where did these returns come from?  The total return of a stock can be divided into three separate sources:  dividends, earnings, and P/E multiple expansion.  First, dividend return simply reflects the cash payments directly passed back to investors.  To be specific, dividends accounted for roughly 2.8% of the total return.  Second, investors may be willing to pay higher prices for companies with greater earnings.  2013 did see record earnings and record revenues and certainly this had an impact on stock price, but the increase in equity prices is disproportionately higher than the increase in earnings.  Specifically, S&P 500 operating earnings increases (year-over-year) account for roughly 6% of the total return.

The third source of stock returns – P/E multiple expansion - must be the key factor.  The P/E ratio is, as most of you know, a quick acid test for the affordability of a company.  If the earnings of a company doubles, then (with all else remaining equal) investors may be willing to pay twice as much for a stock of that company.   For example, if ABC Technology is trading at $30 per share and earns $3 dollars per share, then its P/E ratio is 10X (i.e. $30 / $3).  If ABC Technology’s fortunes change and it begins earning $6 per share, a rational investor might expect its stock price to rise to $60, thus maintaining its P/E Ratio of 10X ($60/$6).  There are other possibilities; for example, other investors in the market may believe that the recent boost of earnings is a one-time event which has no long term impact on the company and let the price stay at $30, thus temporarily depressing the P/E ratio to 5X ($30/$6).  Alternatively, investors might believe that the doubling of earnings is only the first step on ABC Technology’s road to greatness and they may pay $108 for the stock, thus placing the P/E ratio at 18X ($108/$6). 

So, higher P/E ratios reflect greater optimism in market investors and their increased ability to pay higher prices for the same level of earnings.  Simply put, investors in 2013 were more optimistic and became willing to pay more for company earnings. Again, the aggregated stock market did achieve record earnings and profitability levels, but the increase in prices reflects greater optimism in global investors, rather than a commensurate acknowledgement of year-over-year earnings gains.

The Updated Market Targets for 2014: 

Optimism and pessimism, rather than any fundamental factors, moved stock prices in 2013. Of course, there is no way of knowing if the current valuations are fair, too stretched, or still too low.  Further, there’s no way to know is the market’s recognition of fundamental factors will have any impact at all, but that doesn’t prevent market luminaries from making a prediction.

Now that we’ve undermined the faith you may have had in these predictions, we are delighted to present you several S&P 500 forecasts for 2014.  We note - while some market commentators continue to post predictions on economic fundamentals (GDP growth, inflation, etc.) - many have avoided submitting a market forecast this year.  Regarding these forecasts, our only promise is that we will be sure to review these targets next January.  Until then, Happy New Year!


Institution

S&P Forecast for 2014

Ending Value, Dec 31 2013

1848

Credit Suisse

1960

Federated Investors

2100

Barclay's Capital

1900

Goldman Sachs

1900

JP Morgan

2075

Citigroup

1975

Morgan Stanley

2014

Bank of America / Merrill Lynch

2000

Oppenheimer

2014

Deutsche Bank

1850

BMO Capital

1900

RBC Capital Markets

1950

 

SOURCES:

http://www.businessinsider.com/citi-raises-204-sp-500-target-2013-12

http://blogs.marketwatch.com/thetell/2013/12/13/29-stocks-j-p-morgan-says-to-consider-for-2014/

http://blogs.marketwatch.com/thetell/2013/12/03/credit-suisse-lifts-2014-sp-target-to-1960-but-bigger-bulls-exist

http://www.businessinsider.com/morgan-stanleys-new-sp-500-target-2014-2013-12/

http://blogs.marketwatch.com/thetell/2013/11/21/goldman-sp-500-could-drop-10-sometime-during-2014/

http://www.marketwatch.com/story/even-wall-streets-bears-forecast-stock-rally-next-year-2013-12-18

http://www.federatedinvestors.com/FII/marketcommentary/detail.do?cid=107881

 https://www.putnam.com/literature/pdf/CM0100.pdf

https://www.blackrock.com/institutions/en-us/literature/whitepaper/bii-2014-outlook-us.pdf

Gabriel Potter

Gabriel is a Senior Investment Research Associate at Westminster Consulting, where he is responsible for designing strategic asset allocations and conducts proprietary market research.

An avid writer, Gabriel manages the firm’s blog and has been published in the Journal of Compensation and Benefits,...

More about Gabriel Potter
Sign up for our Newsletter
Sign up for our Newsletter