Market May Experience Double-Digit Drop in First Half of 2014


Federal Reserve action gave stocks a short-term boost last week, but without additional news, trading volume is expected to be low through the holidays.

Traders Cheer the Fed
SPDR S&P 500 (NYSE: SPY ) gained 1.94% last week after the Fed gave traders everything they seemed to want. Asset purchases will continue, but instead of buying $85 billion worth of bonds every month, the Fed will only be buying $75 billion a month starting next month.

The general expectation seems to be that there will be a gradual decrease in the purchase amount announced at future Fed meetings unless the economy weakens. Even though the amount of the purchases will be smaller, the Fed should still be adding a significant amount of money to the economy through this program. Reducing purchases by $10 billion after every meeting would result in $460 billion in monetary stimulus to the economy next year.

The Fed is a bullish factor for the stock market in 2014. However, earnings and economic growth will probably be the factors that determine how stocks actually do in the next year. For now, those factors are bullish and gains for the full year seem likely unless earnings disappoint or the pace of economic growth slows unexpectedly. While 2014 is likely to end higher, traders should expect pullbacks along the way.

It is also important to remember that the long-term trend is extended.

SPY has closed above its 20-month moving average ( MA ) for 27 consecutive months. There is nothing magical about the 20-month MA. It is simply the default time setting for Bollinger BandsR and is commonly looked at on charts.

Since the S&P 500 began trading in 1928, I found 21 previous times where the index remained above the midpoint of the Bollinger Bands for two years or more. Assuming you bought at that point and sold one year later, you would have lost money on 14 (67%) of those trades. All trends, even strong uptrends like we are enjoying in the stock market right now, eventually end.

The 20-month MA is about 15% below the closing price of SPY. I believe that is the downside risk in the current market. We will not see an immediate drop to the MA, but I am looking for that level to be reached in the first half of next year.

Gold Faces Year-End Tax Selling Pressure
SPDR Gold Shares (NYSE: GLD ) fell 2.88% last week and reached a new 52-week low. The Fed's decision to taper should decrease the inflationary pressures in the economy. At the end of last week's meeting, the Fed also updated its economic forecasts. It expects to see inflation remain below 2% for at least the next three years. Lower inflation would be bearish for gold.

At the end of last week, GLD was down 28.44% since the end of 2012. Many gold investors are showing losses on their positions. At the same time, many will be showing gains on their positions in the stock market. Some might be tempted to offset the capital gains in stocks with losses in gold.

We could see more selling in GLD before the end of the year as traders look for strategies that might reduce their tax bills. If you are considering a trade for tax purposes, you should consider consulting with a tax professional.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

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This article appears in: Investing , Stocks

Referenced Stocks: MA



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