NEW YORK (Reuters) - U.S. stocks could see their first major pullback in months when the Federal Reserve scales back its economic stimulus early next year but a Reuters poll found shares will still end 2014 up 8 percent from current levels.
Investors have been bracing for a selloff, given this year's big rally that has driven the market to record highs and put the Standard & Poor's 500 index .SPX .INX on track for its best yearly gain in more than a decade.
With economic data, including an upbeat November U.S. payrolls report, suggesting the recovery is building momentum, many strategists expect the Fed move to occur in the first quarter. The U.S. central bank has been buying $85 billion in bonds per month to prop up the economy.
While the market has rallied this year on the Fed’s continued support, any reduction in bond-buying would be further evidence of the economy’s recovery, which should eventually fuel further gains in stocks, strategists said.
“The expected shift in Fed policy will be the primary headwind during the first half, but I expect stocks to recover after an initial selloff and work their way higher over the second half as the global economy continues to improve,” said David Joy, chief market strategist at Ameriprise Financial in Boston.
The S&P 500 is expected to rise to 1,870 by mid-year and end 2014 at 1,925, according to the median forecast from 43 strategists polled by Reuters in the past week. That would represent respective 5 and 8 percent rises from Wednesday’s close of 1,782.
The index is up 25 percent so far in 2013.
The Dow Jones industrial average .DJI is expected to end 2014 at 17,015, up 7.4 percent from Wednesday's close.
An improvement in global economic growth, especially in Europe and other developed economies, should lift the outlook for U.S. stocks and corporate earnings, with some strategists expecting a rotation into growth-oriented sectors from defensive ones.
Earnings are expected to improve in 2014, with growth forecast at 11 percent compared with an estimated 5.7 percent growth in 2013, Thomson Reuters data showed.
“We could be moving from early cycle liquidity-fueled performance to mid-cycle economically sensitive sectors,” said Savita Subramanian, head of U.S. equity and quantitative strategy at Bank of America Merrill Lynch in New York.
While the market has gained sharply in 2013, valuations are not at levels that can be considered expensive, she added.
The forward price-to-earnings ratio for the S&P 500 is 15.3, compared with 13.1 at the start of 2013 and the 14.8 average, based on data going back to 1968, according to Thomson Reuters data.
Still, the Fed’s tapering could cause some portfolio adjustments, especially if there’s a severe pullback in prices.
“A correction is quite possible in Q1,” said Brad McMillan, chief investment officer at Commonwealth Financial in Waltham, Massachusetts. “Could be 15 to 20 percent.”
The majority of economists surveyed by Reuters this week said they expect the Fed will start reducing its bond-buying program no later than March, while some expect the central bank to take action as early as next week. <ECILT/US>
Many strategists said the likely confirmation of Janet Yellen as the next Fed chief should offer few surprises to the market, given that she’s currently the Fed’s vice chair. Ben Bernanke’s term ends January 31.
Additional reporting by Ryan Vlastelica, Rodrigo Campos, Chuck Mikolajczak and Angela Moon; Additional polling by Hari Kishan; Editing by Nick Zieminski