It’s been a very good three-year stretch for large-cap stocks. The annual total returns for the S&P 500 index during the 2012-2014 period have been 16.8%, 32.4% and 13.7%. In contrast, the Ibbotson SBBI Classic Yearbook lists the long-term annualized total return for large-cap stocks as being 10.1%.

Not everyone saw those good returns last year. Domestic small-cap stocks lagged and international markets had their own problems. Preliminary data suggests many active managers struggled to keep up. But the headlines focus on large-cap stocks, and last year was the third consecutive good year for the Dow Jones industrial average and the S&P 500.

The question going forward is whether large-cap stocks can put in a fourth consecutive year of positive returns. Market strategists think they will. Last week, the Wall Street Journal published a summary of forecasts made by 22 strategists and compiled by Birinyi Associates. The average projection called for the S&P 500 to be up 8.2% this year. Six strategists expect another year of double-digit gains. Stephen Auth of Federated Investors was the most bullish, predicting a 14.1% gain. The two most pessimistic strategists weren’t very downbeat, however; Jonathan Glionna of Barclays and David Kostin of Goldman Sachs both predicted a 2.0% gain for the S&P 500.

The calendar is giving mixed signals as to whether the optimism of market strategists is warranted. As AAII founder and chairman Jim Cloonan noted in the October and November AAII Journal, years ending in a five have been positive for stocks. Year three of the four-year presidential cycle has also been positive for stocks. The Stock Trader’s Almanac shows 1939 as the last year that large-cap stocks were down during a pre-presidential year. On the other hand, the Santa Claus rally failed to materialize this year. Thanks to today's upward move, the first five days of January are positive. The January Barometer won’t be set until the end of this month, though a down January may signal either a flat or down full-year as opposed to simply a down year.

Looking at the age of the bull market or the number of consecutive years with double-digit gains doesn’t give a clear answer either. Sam Stovall at S&P Capital IQ counts 11 bull markets as having existed since World War II, prior to the current one. Their durations range from a little over one year (May 1947 through June 1948) to over nine years (October 1990 through March 2000.) Both the average and the median length are about four years, but there is enough variance in the numbers and a small enough sample size that I wouldn’t put much weight on what the typical duration of a bull market has been. The Ibbotson SBBI yearbook shows several past periods where large-cap stocks have gained double-digit returns over periods of three and four consecutive years. Though infrequent, I wouldn’t necessarily say sequences of this duration are unusual. There simply is not a “use by” date we can attach to the current rally.

Valuations are a point of argument. Yale professor Robert Shiller’s cyclically adjusted price-earnings (CAPE) ratio stood at 27.34 as of December 19, 2014. It was last higher in July 2007. The indicator peaked at higher levels in 1929 and 2000. The ratio has gained attention, though Shiller told CNBC last month that while he wouldn’t over-invest in the stock market, he wouldn’t advise getting out either. Thomson Reuters calculates S&P 500 as currently trading at 17.0 times trailing earnings and 15.8 times forward-looking earnings. While neither number is cheap, they are not overly expensive either.

There are, of course, other factors not reflected in the above data. Oil is a wildcard and nobody knows when or at what price it will bottom. Europe is trying to fight off deflation. Members of the Federal Open Market Committee have been projecting 2015 to be the year of the first rate hike since 2012 (13 members said 2015 would be the appropriate year for raising rates at the December 2012 meeting), though the actual decision still depends on how the economic data unfolds. There is also the potential for either a wildcard event or something not getting a lot of attention right now to move the market. In other words, crystal balls remain very cracked.

Certainty is comforting, but investors get rewarded for taking a chance on uncertainty. Those who stayed on the sidelines during the current bull market have incurred a significant opportunity cost. A big part of investing is setting aside fears and realizing that the money being put into stocks is money you need to grow over a period of many years. Wall Street wants you to be focused on the short term so you will trade more often, thereby generating more fee income. Part of your job as an individual investor is to realize that your biggest risk is whether you will have enough wealth over the long term, not what the market may or may not do this year.

As far as whether 2015 will be a fourth good year, the possibility is out there. The market is not in bubble territory (though it is admittedly not cheap either), but stocks will need the help of continued economic expansion, earnings growth and no major negative shocks.

• Using Seasonal and Cyclical Stock Market Patters – Jeff Hirsch explained what he considers to be the “jambalaya” of January indicators.
  
• Valuations, Inflation and Real Returns – Robert Shiller discussed what his CAPE ratio is and what it measures.
  
• What Impact Do Short-Term Moves Have on Your Market Outlook? – Tell us on the AAII.com Discussion Boards
  

First-quarter earnings season will “officially” start next week. Dow components JPMorgan Chase & Co. (JPM) and Intel Corp. (INTC) will report on Wednesday and Thursday, respectively. Joining them will be 14 other members of the S&P 500, including Alcoa (AA) on Monday, CSX Corp. (CSX) on Tuesday, Wells Fargo & Co. (WFC) on Wednesday; Bank of America Corp. (BAC), Citigroup (C) and Morgan Stanley (MS) on Thursday; and Schlumberger (SLB) on Friday.

The first economic report will be the Labor Department’s November Job Openings and Labor Turnover Survey (JOLTS), released on Tuesday. Wednesday will feature December retail sales, December import and export prices, November business inventories and the periodic Federal Reserve Beige Book. The December Producer Price Index (PPI), the January Empire State manufacturing survey and the January Philadelphia Federal survey will be released on Thursday. Friday will feature the December Consumer Price Index (CPI), December industrial production and capacity utilization, and the preliminary University of Michigan consumer sentiment survey.

The Treasury Department will auction $24 billion of three-year notes on Monday, $21 billion of 10-year notes on Tuesday and $13 billion of 30-year bonds on Wednesday.

Philadelphia Federal Reserve Bank President Charles Plosser will speak publicly on Tuesday. Minneapolis Federal Reserve Bank President Narayana Kocherlakota will speak on Tuesday and Friday.

Pessimism among individual investors about the short-term direction of stock prices is at a three-month high, according to the latest AAII Sentiment Survey. Even with the increase, bearish sentiment remains below its historical average.

Bullish sentiment, expectations that stock prices will rise over the next six months, plunged by 10.7 percentage points to 41.0%. This is a three-week low. The drop was not large enough to keep optimism from staying above its historical average of 39.0% for the 20th time in 22 weeks.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, rebounded by 2.3 percentage points to 31.3%. The increase puts neutral sentiment back above its historical average of 30.5%.

Bearish sentiment, expectations that stock prices will fall over the next six months, spiked by 8.4 percentage points to 27.7%. The level of pessimism is the highest seen since October 16, 2014 (33.7%). Even with the big upward move, bearish sentiment remains below its historical average of 30.5% for the 12th consecutive week. Last year (2014), there were 43 weeks with a below-average reading for bearish sentiment.

The stock market’s weak start to the new year had a notable impact on individual investors’ short-term outlook. Geopolitical events, the impact of falling oil prices on energy stocks, a sense that prevailing valuations for other stocks are too high, the pace of economic growth and worries that an even larger decline in stock prices could occur are causing some AAII members to be cautious or pessimistic. Other AAII members remain encouraged by the overall upward momentum of stock prices, falling energy prices, earnings growth and sustained economic expansion.

This week’s special question asked AAII members what they thought would most influence the direction of stock prices this year. There was not a consensus agreement. Slightly more than one out of every five respondents (22%) said the direction and level of oil prices would be a key driver of stock prices. A nearly equal number (20%) said interest rates and U.S. monetary policy will have a big impact. The economy (primarily job growth and the pace of expansion) was a close third, named by 19% of respondents. About 14% of respondents thought geopolitical events—including those in Russia, Ukraine, the Middle East and North Korea—could impact stock prices.

Bullish: 41%, down 10.7 points
Neutral: 31.3%, up 2.3 points
Bearish: 27.7%, up 8.4 points


Bullish: 39.0%
Neutral: 30.5%
Bearish: 30.5%

Individual investors put the largest proportion of their portfolios into equities last month since 2007, according to the December AAII Asset Allocation Survey. Equity allocations exceeded 68%, while cash allocations fell to their lowest level since at least 2000.

Stock and stock fund allocations rose 1.3 percentage points to 68.5%. Equity allocations were last higher in June 2007 (68.6%). Last month’s increase puts stock and stock fund allocations at or above their historical average of 60% for the 21st consecutive month and the 23rd out of the past 24 months.

Bond and bond fund allocations rebounded by 0.8 percentage points to 16.8%. The increase keeps fixed-income allocations at or above their historical average of 16% for the seventh consecutive month.

Cash allocations fell by 2.0 percentage points to 14.8%. As noted above, the drop puts cash allocations at their lowest level since at least 2000. (The allocation numbers were rounded prior to May 2000.) Last month’s drop kept cash allocations below their historical average of 24% for the 37th consecutive month.

The unusually high allocation to stocks coincided with new record highs being set by large-cap stocks. At the same time, optimism about the short-term direction of stock prices mostly stayed above average throughout the month of December. Many AAII members also continued to be frustrated by low bond yields and low interest rates on money market accounts.

Last month’s special question asked AAII members how their year-end portfolio allocations compared to what their expectations were at the beginning of 2014. Nearly half of all respondents (45%) said their year-end allocations matched or were close to their expectations. About 17% of respondents said their year-end equity allocations were larger than they had anticipated. Approximately 8% said that they were holding onto more cash than expected.

Here is a sampling of the responses:

• “Right on target. I’m surprised I held onto my bond funds as long as I did.”
• “More cash and less equities as I was nervous of the run up [in stock prices].”
• “Similar. I try to keep 1/3rd in fixed-income and 2/3rd in equities.”
• “Thought I would have more bonds at higher [interest] rates.”
• “More cash than expected. Normally, I’m very close to fully invested.”
• “Just rebalanced in October.”
• “Right on target. I rebalance periodically.”

• Stocks and Stock Funds: 68.5%, up 1.3 percentage points
• Bonds and Bond Funds: 16.8%, up 0.8 percentage points
• Cash: 14.8%, down 2.0 percentage points

• Stocks: 32.2%, up 0.5 percentage points
• Stock Funds: 36.3%, up 0.8 percentage points
• Bonds: 3.4, down 0.1 percentage points
• Bond Funds: 13.3%, up 0.8 percentage points

Take the Asset Allocation Survey.

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