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5 risks that could upend bullish 2014 thesis

10:34 AM, Jan 1, 2014   |    comments
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USA TODAY - Wall Street bulls say the good times can continue in 2014. But despite articulately laying out a bullish case for stocks, they also admit that there are risks to their upbeat forecast.

Here are five things that could go wrong next year, and trigger the first sizable correction since late 2011.

RISK NO. 1: A MARKET 'MELT-UP'

A repeat of last year's eye-popping 25% to 40% returns in 2014, market strategists warn, could potentially spawn a 2000-style stock market bubble that could trigger a market decline far worse than a garden-variety 10% correction.

"Melt-ups are fun when they are happening but they tend to end in much bigger corrections," says Liz Ann Sonders, chief investment officer at Charles Schwab.

Wall Street prefers a steady rise in prices from current levels, with gains in the 5% to 10% range, so prices don't get disconnected from earnings, says David Kelly, chief global strategist for JPMorgan Funds.

The reason: The melt-up scenario, which could be driven by a mountain of cash arriving late to the stock market party or a stimulus-fed bubble, will likely turn a market now considered "fairly valued" into overvalued territory.

"Be careful what you wish for," Kelly says.

RISK NO. 2: A MESSY FED 'QE' EXIT

Investors have become addicted to stimulus. And even though Wall Street in December took news of the start of the Federal Reserve's exit from its bond-buying program in stride, expect more "taper tantrums" in 2014, says Ann Miletti, senior portfolio manager at Wells Fargo Advantage Funds.

"Maybe the Fed executes perfectly and it doesn't create a lot of waves," Miletti says. "But I would anticipate a withdrawal period. Interest rates won't stay ultra-low forever. In the long run the economy not needing as much stimulus is a good thing. But there will be disruptions along the way. But we would be buyers at lower entry points because we believe in the longer-run story."

RISK NO. 3: A RETURN OF IRRATIONAL EXUBERANCE

If first-day IPO price pops or the Dow's stunning rise garner more water-cooler chat time than, say, the first outdoor Super Bowl in wintry New York or Beyonce's latest hit, watch out. It could signal that bullishness has gone mainstream and irrational exuberance is back. Everyone knows what happens when everyone thinks stocks or home prices can't go down.

The market is not at an optimistic sentiment extreme yet, Sonders says. Individual investors are just now starting to funnel money back into the stock market after withdrawing cash for five years. And bullishness on Main Street, while rising, is far from prior peaks. Institutional investors like hedge funds also remain underinvested in stocks.

But investor sentiment bears watching. "If you got to an extreme in bullish sentiment you could point to that solely as a reason for the market to consolidate its gains," Sonders says.

RISK NO. 4: A "DEFENSIVE" CLASS OF CEOs

If CEOs are unwilling to go on the offensive and start deploying more of the $1.2 trillion in cash sitting on their balance sheets it could take away a key plank of the economic growth story. "The key question is what are they going to do with all that cash?" says Terry Sandven, chief equity strategist at US Bank Wealth Management.

If CEOs remain tight-fisted, it means less jobs, less spending on tech upgrades, less new plant openings and less M&A activity. In short, less spending means less economic growth.

RISK NO. 5: A "GROWTH SCARE"

Wall Street is betting on faster growth, perhaps a return to 3% GDP.

But faster growth is not assured, given that interest rates are on the rise. And if global growth doesn't materialize, the bull case weakens, says Marty Sass, CEO of money management firm M.D. Sass.

If a market storm does occur in 2014, it will likely result from a "growth scare," warns Jeffrey Kleintop, chief market strategist at LPL Financial.

(Copyright © 2013 USA TODAY)

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