The Dow Jones Industrial Average (DJINDICES:^DJI) returned 26.6% last year and the S&P 500 was up 29.1%. Those are incredible returns no matter the year, but can the stock market do it again in 2014? There are reasons to be concerned and reasons to be bullish going into next year.
This year won't be like last
First, let's cover a few reasons 2014 will be different than 2013.
One of the reasons stocks moved higher in 2013 was that bonds were so unattractive. But now that the Federal Reserve is slowly pulling money from QE3, an $85 billion-per-month bond buying program, bond yields are rising and bonds will attract more money in 2014.
Then there's the fact that stocks are a lot more expensive than they were a year ago. The Dow Jones Industrial Average has a P/E ratio of 17.0 today and was just 14.9 a year ago. Multiple expansion drove the market, and P/E ratios could certainly go higher, but unless earnings rise significantly this year I don't see companies justifying higher valuations.
Last year was a strange one for stocks in that the market was driven by few attractive alternatives and by optimism for the future, not by fundamental strength from the companies investors were buying. I don't expect the same drivers to exist this year, but that's not a reason to sell now.
Why 2014 could be great
There are some significant signs that the economy and companies will have a great year this year.
On a macro level, the economy continues to improve. The unemployment rate is falling, GDP growth is improving, consumer confidence is growing, and U.S. manufacturing continues to expand. Those factors will drive the market long-term because they'll help drive earnings higher.
If improving employment drives growth, then companies will see more opportunities to put the $1.48 trillion on corporate balance sheets to work. That'll be like fuel to the recovery and help GDP, employment, and earnings.
I think earnings growth will be key for stocks in 2014, but that's a lot harder to accomplish than just expanding multiples. It's an uphill battle to reach 2013's gains but the market has a puncher's chance.