CITI: Bull Market Will Continue, But Bumpy Road Ahead

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Citi Research issued a new report last week titled “North America Road Ahead 2014”. In the report, Tobias M. Levkovicz and colleagues assess current economic conditions and make a number of investment suggestions based on their prognostications for the coming 12 months.

The report begins by saying the analysts believe the “raging bull thesis is intact”, but they “expect a bumpier road in 2014.” They explain this apparently inconsistent position by saying that the macroeconomic background seems to be gradually improving, but a number of events — especially the Fed taper and a slew of negative earnings revisions — could create some significant market volatility.

Earnings growth will drive markets

A central thesis of this Citi report is that stock price appreciation is likely to be driven by real earnings, not anticipated improvements in earnings. This thesis obviously dovetails well with the call for increased volatility, as Citi also says they expect to see another round of negative earnings revisions in the first quarter of 2014. Throw in the Fed taper and a little Euro periphery worry and you have the makings of a skittish market looking for an excuse to correct.

That said, once you get beyond Q1 and earnings are back on track, Citi says a number of sectors — especially tech and quality big cap consumer plays — could enjoy a strong second half of 2014.

2014 earnings estimates

Despite calling for negative earnings revisions in early 2014, Levkovich et al still see earnings improving for full-year 2014. “We estimate 2014 EPS at $117.50 versus $110.10 in 2013, which reflects better GDP trends (see Figure 5) as well as the potential for EBIT margins to improve (see Figure 6) as top-line growth ensues.”

High-quality large caps and growth stocks for 2014

Citi says their models indicate large cap equities and growth stocks are likely to outperform over the next 12 months. In an overview, they suggest, “Positioning should be much more important in 2014 and style investing favors large caps and growth. Our proprietary lead indicator model clearly argues for growth (see Figure 11), while large caps versus small cap valuation differentials (see Figure 12) contend that there is a 72% chance that bigger cap names outperform. Given our concerns that volatility will pick up in 2014 looking at past indications (see Figure 13); a somewhat less risky portfolio makes sense as well.”

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