I'm not going to update my model until data is available for the end of the year. I will then have year-end figures to refer to during the coming year.
2013 was a banner year for investors and speculators as the market increased substantially without any significant corrections. Why did the market perform so well? It really wasn't do to better than expected earnings. Estimates for 2013 at the beginning of the year were in the $108 - $110 range for the S & P 500 and earnings will be lucky to reach $107 when the final quarter is reported. Optimism, though, prevailed during the year and estimates for 2014 were held at high levels so investors could always hope for more growth next year. Other economic indicators improved marginally as the year went on. GDP was up more than 4% in the third quarter and unemployment declined to 7% as the year concluded. So, basically, valuation increased substantially as investors grew more optimistic that the economy would improve.
An even more important factor, in my opinion, was the huge money-printing operation conducted by the Federal Reserve during the entire year. Low interest rates on cash and Treasury securities forced many investors into the stock market in an attempt to replace lost interest income with dividends. This had the effect of producing bubble-like conditions - especially in the 4th quarter.
My model is a device for controlling risk while taking advantage of stock returns when they are judged to be attractive. During the first three quarters of the year, my model reflected a mediocre outlook and fluctuated around a 50% market exposure - sometimes 75% and sometimes 25%. During the fourth quarter, though, exposure has declined to essentially zero as sentiment factors became increasingly bearish. For the full year, my model returned about 1/2 of the S & P 500 return. I view those results as somewhat disappointing but, given the fact that there were essentially no corrections in stock prices during the year, the results are not too surprising.
Looking at 2014, I expect a correction in stock prices to begin very soon. That correction could be substantial and could occur very quickly. I don't know what the catalyst for such a correction might be - that will become evident as time progresses. Essentially, I am basing my forecast on valuation and sentiment factors. Stock prices are high and everyone seems to be already onboard. To put probabilities on my expectations, I think there is a 75% chance of a greater than 10% correction beginning in the first quarter. I would assign a 15% chance of a less than 10% correction and only a 10% chance of no correction at all. Given the position of my sentiment indicators, I would have to consider junking them totally if a noticable correction doesn't occur. I remain fully hedged.
Happy New Year!
With my wife on Aruba