Clark: Pullback Buying Opportunity

January 16, 2014

After a stellar 2013, the way ahead looks choppy, but promising.

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article features K. Sean Clark, CFA, chief investment officer of Philadelphia-based Clark Capital Management.

Coming on the heels of a fantastic 2013, momentum analysis suggests that 2014 could be a good year. We want to review some of the favorable trends at play in the U.S. equity market and look at some of the risks that may affect the direction of the market in the new year.

From a fundamental viewpoint, a strengthening economy is providing a solid measure of support for stocks, and, consequently, the bull market in stocks deserves the benefit of the doubt.

Last year was a great year for the market, with the S&P 500 up 32.3 percent, and history suggests that good years tend to follow great years. On average, the S&P 500 rose 10.0 percent in the year following a 20 percent or greater advance (versus an average gain of 8.7 percent for all years since 1945) and the S&P increased in price nearly 80 percent of the time versus the more normal 70 percent.

So, this suggests that the strong momentum experienced in 2013 should carry over to 2014. In addition, the S&P 500 posted a 10.50 percent gain in the fourth quarter, one of its best fourth-quarter performances of the past 85 years. A big question many are asking as we enter 2014 is if the strong momentum will carry through to the new year or if a first-quarter pullback is in order.

History suggests that momentum should be respected. Following the top 24 quarters since 1928—with a return of 8 percent or greater, markets have rallied well in excess of the longer-term averages to start the new year, with median returns of 3.6 percent and 5.9 percent in January and the first quarter, respectively.

The Yellen Catch

However, there are several historical factors suggesting that 2014 will not be as smooth sailing as 2013.

Two areas that give us pause are that a new head at the Federal Reserve takes over on Feb. 1, and 2014 is a midterm election year. First, given the change of chairmanship at the Fed, it’s a perfect time to examine how the market has treated new leadership at the Fed.

Janet Yellen was confirmed to be the first chairwoman of the Federal Reserve at a crucial moment in Fed history, just as it attempts to scale down its “quantitative easing” bond-purchase program.

Navigating the removal of $85 billion per month bond-buying program is a big challenge. In addition, the markets have a tendency of testing new leadership at the Fed. The average market drop in the first six months after a new chairperson is appointed has been 16.1 percent. Whether history will repeat itself is unknown at this time, but it is a unique risk factor that investors should take note of.

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