The opening bell could ring a little more optimistically in 2014, but the stock market is unlikely to continue its sizzling pace of gains.
This year is expected to close out on an up note, with the S&P 500 up nearly 30 percent—the best year since 1997. The 2014 trading year kicks off Thursday, after the New Year's Day holiday. Part of the optimism has to do with a slight shift in sentiment about the economy, after a string of positive data surprises and upward revisions in third-quarter GDP took it to 3.6 percent growth from an initial 2 percent.
"A month and a half ago, you would have thought we'd have [fourth-quarter] growth of 1 percent," said Daniel Greenhaus, chief global strategist at BTIG. "It's been a very rapid readjustment of expectations."
That readjustment helped drive the yield on the 10-year over 3 percent in the past week. Data on personal spending and durable goods orders both showed unexpected pops, and jobless claims fell more than expected, to 338,000 in the past week. While a 3 percent yield is viewed as a psychological hurdle, stocks ended the week with gains.
Important data in the week ahead includes consumer confidence Tuesday and ISM manufacturing data and weekly jobless claims Thursday. Fed Chairman Ben Bernanke appears at the American Education Association annual meeting in Philadelphia, where he will discuss the changing Fed and answer questions from the audience of economists.
"If ISM holds at these levels, you're going to think that GDP comes in at 3 percent plus" for the fourth quarter, Greenhaus said. ISM was reported at 57.3 in November and is expected to come in just under that, at 56.7—reflecting strong expansion.
Economists still expect GDP to be closer to 2 percent for the fourth quarter, but the distinct improvement in the outlook has helped drive selling in bonds. Unlike in the late summer, the rising yields have not stung stocks.
"It's an entirely different environment," Greenhaus said. "We're going to have two back-to-back strong quarters for the first time in a long time."
Zane Brown, fixed-income strategist at Lord Abbett, expects fourth-quarter growth to come in closer to 2.5 percent than 3 percent. He was surprised that stocks kept gaining even with the rise in yields to a level that gave the market pause in September. "The stock market has had a mind of its own," said Brown, adding that stocks defied conventional wisdom and have been climbing since the Fed announced that it would taper bond purchases.
Brown's concern is that housing may not be as strong as the seven-year high in starts suggests, especially as mortgage rates should rise further next year. He sees the 10-year yield pulling back, with concern about the economy, and it could trade at 2.80 percent before it moves to end the year at 3.5 percent.
But pros say this year's stock market party won't be as big as last year's and will be harder to navigate, despite the fact that the economy appears to be gaining momentum. The transition could mean more volatile markets. Greenhaus said stocks always move ahead of the improvement in the economy, and he expects gains to slow. He expects the S&P 500 to end the year at 1,980, up nearly 8 percent.
Management, is more negative, and he sees stocks ending flat on the year, setting up for gains in subsequent years. Some of the things that come with a better economy—such as inflation—could pose a problem, and he expects the markets could force the Fed to move off its accommodative policy even more quickly.
The Fed said it would gradually taper back its bond-buying program, or quantitative easing, announcing that it would reduce its monthly $85 billion purchase by $10 billion starting in January.
"The history of monetary policy changing direction is not good for the financial markets," Paulsen said. "There's a pretty long history that's been replicated over and over again. It really suggests a more challenging year."
He has been one of the more positive strategists over the past few years but this year lags many of Wall Street's other strategists. Barclays, Goldman and Citigroup see the S&P at 1,900 at year-end, while Bank of America Merrill Lynch expects 2,000 and JPMorgan 2,075. Paulsen expects the yield on the 10-year to end the year at 4 percent, while most Wall Street firms forecast 3.5 or 3.75 percent as the top of the range.
"I think for a while, stocks are going up and probably bond yields do, too," he said. "But at some point you're going to cross the line where that good news becomes bad."
For the time being, though, analysts project that the market will move higher. According to S&P Capital IQ, in the past 10 years, the period between Christmas and Jan. 7 has seen a gain 70 percent of the time. The average gain has been about 1 percent. S&P also notes that since 1990, whenever the S&P has been positive in December, it has been positive in January 70 percent of the time, with an average gain of 2 percent. The S&P has been positive 17 times in December since 1990.
Stocks finished the week with gains, even though the market stalled out Friday with slight losses. The S&P was up 1.3 percent for the week at 1,841, and the Dow was up 1.6 percent at 16,478. The Nasdaq was also up 1.3 percent at 4,156. The 10-year yield was just above 3 percent late Friday.
THE WEEK AHEAD:
10:00 a.m. Pending home sales
10:30 a.m. Dallas Fed Survey
9:45 a.m. Chicago PMI
10:00 a.m. Consumer confidence
S&P/Case-Shiller home prices
New Year's holiday
10:00 am ISM manufacturing
10:00 a.m. Construction spending
Monthly auto sales
1:15 p.m. Fed Gov. Jeremy Stein, at American Economic Association, Philadelphia
2:30 p.m. Fed Chairman Ben Bernanke at AEA meeting, subject: "The Changing Federal Reserve: Past, Present, Future"