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Past is not prologue: Looking ahead at 2014

A year ago this time, Americans were on the brink of a fiscal cliff. The start of 2013 was poised to bring the expiration of several key tax cuts which had been created to encourage investments and propel the economy.

Throw into the mix the mandatory spending cuts associated with sequestration and the stage was set for a bearish start of the year on Wall Street. After all, with no resolution on the horizon, investors decided to sell at the end of 2012 rather than wait to see what was in store.

Of course, as Congress is prone to do, it waited until the first day of the year to pass the American Taxpayer Relief Act of 2012 -- which President Obama signed the next day -- and the plunge off the cliff was avoided.

It also sparked an amazing stock market rally. The Dow Jones industrial average started the year just below 13,000 -- and with the exception of a few dips along the way -- has moved steadily higher, posting an annual gain of 20 percent and setting all-time record closing highs at least 45 times.

Since hitting a post-recession low of 6,547 on March 9, 2009, the Dow is up 140 percent.

Amazingly, the Dow was the laggard among the major stock market indexes. The S&P 500 stock index likely will post a gain of more than 25 percent in 2013 and the Nasdaq composite index is on track for a staggering annual return of 35 percent.

Of course, investors are always quick to ask, “What have you done for me lately?”

Few Wall Street wizards came close to predicting the kind of returns realized this year. And you can hardly blame them for being cautious heading toward 2014. After all, the markets have gone several years without so much as a 10 percent correction along the way.

While past is not prologue, Sam Stovall, chief equity strategist at S&P Capital IQ, says a great year can be followed by a good year. His research finds that since 1945, there have been 21 times the S&P 500 gained more than 20 percent. In the following year, the S&P 500 recorded an average increase of 10 percent, compared to an average price gain of 8.7 percent for all years since World War II.

“We believe 2014 could be one of those years in which the S&P 500 is up for the entire year, but also has to suffer through a pullback of at least five to 10 percent, and more likely a correction of 10 to 20 percent, before ending the year higher than where it started,” Stovall said.

The prospect of a 20 percent correction has some Main Street investors ready to cash in their 2013 gains. For instance, a report from research company Lipper says investors pulled $6.51 billion out of stock mutual funds in the week ending Dec. 11, the biggest liquidation since August 2011.

Where did the money go? Lipper says the bulk of the money moving out of stocks flowed to liquid money market mutual funds with yields barely above zero.

Will these investors have the nerve to get back into stock again in 2014? History says yes, but probably not until big gains have already been racked up. However, investment professionals will seize any sell offs similar to what Stovall said could happen as a buying opportunity.

“Just live through it, and buy on the dips to buy opportunity,” said Dr. Elaine Garzarelli, a Wall Street veteran analyst. “Add to your positions in cyclical sectors of the economy, which would be technology, industrials, financials, and consumer durables.”

Liz Ann Sonders, chief investment strategist at Charles Schwab (NYSE: SCHW), shared Garzarelli's view there could be bumps along the road in 2014, but said patient investors were rewarded handsomely this year for not bailing out when things looked bleak -- even after the fiscal cliff scare.

“Throughout the following months we saw political problems in Europe, an international crisis in Syria, another U.S. government shutdown, a botched rollout of the Affordable Care Act, and the word 'taper' entering the investment lexicon.” Sonders said. “A lesson from 2013 was that waiting for the perfect opportunity to get into stocks means taking the risk of being out of the market during a strong upside run.”

To be sure, 2014 will not be smooth sailing on Wall Street. The Federal Reserve will certainly begin tapering and slowly remove economic stimulus to ward off any potential for inflation. Another debate in raising the debt ceiling will begin early in the year and, of course, an important midterm election will affect the makeup of Congress.

In other words, a potential perfect storm that could push stock prices higher again. But be prepared for some scary bumps along the way.

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