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Portfolio > Alternative Investments > Private Equity

Buckingham, Saut, Stovall Share 2014 Stock Picks

By Jane Wollman Rusoff

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Bullish and optimistic, but not wildly optimistic. That sums up the equity outlook for 2014 by five top equity strategists whom ThinkAdvisor interviewed recently.

While the supersize gains of 2013 — marked by the S&P 500’s rising some 25% — have stolen from what might have been an outsize upside in 2014, the year ahead should be a healthy one for stocks despite a long-overdue pullback, strategists forecast.

“As we go into 2014, I don’t think it will be euphoric in terms of investors throwing money left and right at the stock market. But stock pricing is going to matter again, and value will reassert its historical dominance,” says John Buckingham, chief investment officer of Al Frank Management and manager of the Al Frank Fund, who is based in Aliso Viejo, Calif.

That correction on the horizon most likely will be triggered by the Federal Reserve’s starting to taper bond-buying in the first quarter of the year. The Fed announced Wednesday that it would slow its bond purchases to $75 billion a month from $85 billion beginning in January.

“Like a Ping-Pong ball dropping on a table, the first reaction is the greatest,” says Sam Stovall, chief equity strategist, S&P Capital IQ, based in New York City. “You might have subsequent reactions, but they’ll be less dramatic.”

Stovall expects a decline of 10% or more next year but none that moves into bear territory; that is, a drop of at least 20%.

Corrections are meant for buying, according to Jeffrey Saut, chief investment strategist at Raymond James, in St. Petersburg, Fla. “The equity markets don’t care about the absolutes of good or bad,” he said. “All they care about is: Are things getting better or are things getting worse? And things are getting better in lots of ways.”

These include slowly improving markets in U.S. employment, housing and retail sales, in addition to an accelerating global economy.    The U.S. economy, though still climbing sluggishly, seems poised to grow faster than it has in the last five years. A predicted GDP growth rise to 2.5% to 3.5% in 2014 from its current 2% could be a catalyst for investors to add stocks to their portfolios.

“That just may be the sweet spot for the equities market. I’m very bullish on next year,” Saut says. “When you start growing at 7% to 10% GDP, that’s when bubbles develop.”

The S&P 500 is predicted to end 2014 at about 1900 to 2000. Targeting 2000, a BofA Merrill Lynch Global Research report calls for “strong U.S.-led economic growth, higher yields and solid U.S. stock gains that are lower than in 2013 but higher than consensus.”

While not cheap, stock prices are now in line with long-term averages, and further price-earnings expansion next year is generally seen as unlikely, according to the strategists interviewed.

“Growth will be limited to earnings improvement. It’s a sort of show-me market,” Stovall says.  “Earnings growth looks realistic, and the valuations are not stretched, certainly not at bubble levels. It’s a good time to invest in equities.”

Unlike in 2013, next year has a better chance to deliver on slightly better earnings growth, says Kate Warne, investment strategist with Edward Jones, in St. Louis.

BofA Merrill Lynch’s expectation is for earnings to grow 7% next year and “a bit more multiple expansion.”

Returns in 2014 are anticipated to be in the 6% to 8% range, but 10% to 14% would not be unreasonable, some strategists say.

As for tapering, the Fed’s intended bond-buying reduction has already begun to play a part in the direction of the equities market. “Investors are anticipators – [like] hyperactive first-graders playing musical chairs,” Stovall says. “That’s why the S&P lost nearly 6% last summer for fear that the Fed would accelerate the start of tapering.”

But just as in 2013’s second half, when the bond market fell out of bed and investors shifted portions of fixed income money into equities, so will bond money continue flowing into stocks in 2014.

“People are seeing that the grass is very much greener on the equity side. They’re still nervous and cautious, though, and haven’t shifted too much out of bonds yet,” Buckingham observes. “And that’s a positive thing. I just don’t see irrational exuberance.”

He continues. “The Fed isn’t about to take away the punch bowl. Even if they cut bond buying from $85 billion to $50 billion a month, that’s still an unprecedented and highly accommodative stance on monetary policy.”

Warne notes that when tapering begins, “investors need to be prepared and use any [resulting] pullback as an opportunity to add stocks to their portfolios.”

Scott Wren, senior equity strategist, Wells Fargo Advisors, in St. Louis, says he would “love to see a pullback. It would give clients the opportunity to put a little sideline cash to work, which they definitely need to do.”

Favorite sectors for 2014 include economically sensitive ones, such as consumer discretionary — pegged to post a 17.8% earnings increase next year, according to Stovall — energy and industrials, as well as technology and materials.

“Next year’s advance is going to be led by cyclical sectors,” Wren says. “We’re on the offensive: We want our clients to put cash to work in sectors that are sensitive to the ebb and flow of the economy and to be where they can benefit from that.”

Buckingham is overweight energy, industrials, materials and information technology and within those, favors equities that include Ensco PLC (ESV), Caterpillar (CAT), Mosaic (MOS) and Apple (AAPL), all of which were laggards in 2013, he says.

Warne likes technology because of an expected pickup in capital expenditures. “These stocks benefit from faster growth,” she says. “Businesses have been sitting on mountains of cash. Next year, you’ll see them return to investing a bit more — one of the first ways [historically] is in new software and hardware.”

Warne also likes “some of the expensive sectors” — such as biopharmaceuticals or health care products — that stand to “benefit from other changes.” Most of the strategists call for underweighting utilities, consumer staples, telecommunications, health care and financials.

Looking long term, BofA Merrill Lynch recommends that investors “do the opposite of what worked over the last cycle…[Next year] large or cash-rich companies could outperform small or more levered companies … And high-quality companies (stable growth, not low beta) that have seen no multiple expansion during the last 10 to 20 years of hyper-stimulus could re-rate higher,” the firm’s report says.

In global equities, S&P Capital IQ’s Stovall predicts “developed economies near doubling in GDP growth.” The firm’s global equity strategist Alec Young noted in a company Webinar that “the global economy is poised for some of its best growth since 2010.”

In fact, Warne “likes global better than the U.S. because,” she says, “as we see countries in Europe come out of recession, valuations are more attractive; and the dividend yields are high. This is one of the best times to buy stocks. We’re bullish outside the U.S. and in the U.S.”

Emerging markets are anticipated to see modest growth next year.

“They’re in the process of trying to boost domestic demand, so emerging markets will be a little dicey,” Wren says.

All in all, strategists look for a good year in equities but a highly volatile market punctuated by a correction. They forecast, however, that more investor money should leave the sidelines.

“People are profoundly underinvested in U.S. stocks. The stock market is fear, hope and greed — only loosely connected to the business cycle in the short-to-intermediate term,” Saut says. “Greed always brings back investors.”

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Check out more 2014 outlooks on ThinkAdvisor and these stories by Jane Wollman Rusoff:

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