5 risks facing investors through year-end 2014

It has been an easy summer for investors, with smooth gains and low volatility. Nothing so vulgar as to distract from the important stuff like sun-worshipping. And after a Ukraine-related slipup in early August the S&P 500 has blasted to new record highs and is hovering at the 2,000 mark.

But with summer vacations over and Wall Street returning to the grind, can the good news continue? Morgan Stanley (MS) sure thinks so. It made waves recently with a call for the S&P 500 to hit 3,000 by 2020, based on its belief that the U.S. economic expansion still has legs.

Maybe so, but the more immediate future holds a number of big hurdles that could trip up stocks in the months to come.


For one, the geopolitical situation remains in flux. On Wednesday, stocks celebrated -- prematurely -- overnight headlines that Ukraine and Russia had agreed to a permanent cease-fire deal. It turns out their respective leaders merely agreed to the outlines of a possible peace deal as the fighting between Kiev's forces and pro-Russian separatists continues.

A resolution still seems distant. And with ISIS extremists active in Syria and Iraq, and with Islamic militants capturing airliners in Libya, a possible terrorist attack on the West remains an active threat -- something officials including Secretary of Defense Chuck Hagel has warned of.

Second, a number of major central bank decisions loom -- which is critical given how dependent financial markets have become on cheap money stimulus. The Federal Reserve is expected to end its bond-buying program in October, leaving the market without a steady drip feed of demand into the fixed-income market for the first time since 2012.

Prior periods without Fed bond buying in 2010 and 2011 were associated with market turmoil.

Pressure is also building on the European Central Bank, which is contending with higher unemployment and low inflation, to do more to support the eurozone economy. A lack of action would be a big disappointment.

Third is a risk that weak economic conditions overseas will weigh on the relatively strong U.S. economy.

While Japanese wages were good, other data there hasn't been so hot, such as last week's poor report on Japan's car sales. Emerging market economies are reeling, with Brazil suffering from both inflation and recessionary pressure (although its stock market is surging anyway). Europe is hurting, with factory activity dropping in the U.K., Poland and Spain, while unemployment is still high. And China's economy, despite a recent mini-stimulus in response to credit market troubles, hasn't reaccelerated as many expected.


Fourth, the bond market is looking vulnerable -- particularly junk bonds -- as the High Yield Bond SPDR (JNK) stalls near resistance from its June/July highs. This is likely the result of the pending end of the Fed's bond buying because similar weakness was seen in May last year when the Fed first hinted it was preparing to pull back on this program.

And finally, the potentially very contentious midterm elections loom in November. With a GOP takeover of the Senate the most likely outcome, we could see a return to the fiscal face-offs between Congress and the White House that we haven't seen since 2012.

As for the long-term outlook, Morgan Stanley is looking for the S&P 500 to rise another 50 percent over the next six years on the expectation that America's economic expansion has longevity. For example, it estimates that several broad economic indicators have only just reached "normal" expansionary levels and are far from being unsustainably extended.

Arguing against that is history. Since the 1850s, according to the National Bureau of Economic Research, economic expansions last on average 39 months. The current recovery started in July 2009 (with the job market not turning around until 2010), so it's already 61 months old.

But it's also true that economic expansions have become more persistent, with an average length of 58 months since 1945. The last three expansions have averaged 95 months. A similar performance would put the start of the next recession sometime in 2017 or early 2018.

So, while the rest of 2014 could be bumpy, investors would be wise to use any sell-off as a buying opportunity for the long haul.

  • Anthony Mirhaydari

    Anthony Mirhaydari is founder of the Edge , an investment advisory newsletter, and Edge Pro, options newsletter. Previously, he was a markets columnist for MSN Money; a senior research analyst with Markman Capital Insight, a money management firm; and an analyst with Moss Adams focusing on the financial services industry.