(12/20/13) S&P's Outlook for 2014

Even though the S&P 500 is up more than 20% thus far in 2013, investors would be mistaken to expect a similar result in 2014, in our opinion, forecasts Sam Stovall, chief equity strategist of S&P Capital IQ in The Outlook.

Projecting such a repeat next year would be the “fallacy of forecasting recency.” However, history does tell us that good years typically follow great ones.

Since 1945, there have been 21 times that the S&P 500 (SPX) gained more than 20%. In the following year, the S&P 500 recorded an average increase of 10%, versus an average price gain of 8.7% for all years since World War II.

In addition, these good years recorded a positive performance 78% of the time, versus a 71% frequency of advance for all years.

This subsequent good year was not achieved without challenges, however. Each one had to ride out at least one intra-year decline in excess of 6%, and some years—such as 1950, 1986, and 2010—suffered through more than one.

Indeed, during ten of these 21 good years, the S&P 500 declined a minimum of 6.2%, and as much as 19.3%, while still registering a positive performance for the entire year.

Other years also saw calendar-year advances, even though the S&P 500 peaked late in the year and initiated a downward spiral that bottomed in the subsequent year. Finally, four of the 21 years following gains of 20% or more, posted full-year declines from 6.6% to 11.9%, because they slipped into new bear markets.

S&P Capital IQ's Investment Policy Committee has a 12-month target for the S&P 500 of 1895, which is the median forecast, from all committee members, based on their area of investment forecasting expertise, be it economic, fundamental, quantitative, technical, or historical. This 1895 level implies a 5% price gain from the end of November.

We also believe 2014 could be one of those years in which the S&P 500 is up for the entire year but suffers through a pullback of 5%-10% (and more likely a correction of 10%-20%) before ending the year higher than where it started.

One reason is that 26 months have elapsed without the S&P 500 slipping into a correction, versus the average of 18 months (and median of 12 months) between declines of 10% or more since 1945.

And since we believe stock market corrections have not been repealed, but are oftentimes delayed, we think another correction will occur within the coming calendar year.

Adding credence to this forecast, in our opinion, is that 2014 is a mid-term election year, which falls into the cycle of the four-year low. Since WWII, the S&P 500 has endured 12 bear markets, with seven of them occurring in a mid-term election year (1962, 1966, 1970, 1974, 1982, 1990, and 2002).

Severe corrections concluded in two more: 1978 (-19.4%) and 1998 (-19.3%). However, these were not deep enough to be bear markets. What's more, there have been three mega-meltdowns, or declines in excess of 40%, since 1945, and two of these three ended in a four-year cycle low year.

Since we believe the US equity market does follow a cyclical pattern, we think it will be susceptible to slipping into a correction of between 10%-20% in 2014.

So, there you have it. S&P Capital IQ's Investment Policy Committee regards itself as being bullish, but with a lowercase “b.” So, while a great year may not be in the cards, we think a good one is.