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Five Things That Could Go Wrong in 2014

"Risk is always at its greatest when you don't think there's risk."

[Editor’s note: The following is a cross post by Patti Domm that originally appeared on]:

The outgoing year certainly earns its place in history as one of the best of times for stocks.

It was pretty much smooth sailing to a new high on the S&P 500 of 1,848 -- a 30 percent gain with no correction greater than seven percent. Stocks in the coming year are also expected to make good strides, but no forecasts come close to the performance of 2013.

But 2013's advantage over the coming year was that the market was able to climb a wall of worry -- starting with the fiscal cliff last New Year's Eve, through the government shutdown in October, and up to the Fed's announcement in December that it would pull back on stimulus.

Strategists are optimistic for 2014. Unlike in 2013, however, they say there is no one big catalyst to fear -- one major event that's sure to trip up the stock market's advance.

"Risk is always at its greatest when you don't think there's risk," said Citigroup chief equities strategist Tobias Levkovich. "If you think it's perfect sailing, you don't wear a seat belt."

There are, however, several potential trouble spots to watch, and most of them expect to see a pullback sometime in 2014.

5. Rising rates: The first worry is the possibility of a sharp, rapid move higher in interest rates. While an improving economy should be able to withstand a higher rate environment, the concern is that rates could rise too much, too fast.

Since the Fed announced it would taper its $85 billion monthly bond-buying program, interest rates have been rising, helped also by improving economic data. The 10-year yield Tuesday touched 3.03 percent, closing the year at its the highest level since July 2011.

"Trouble usually comes from the bond market, and the bond market is in the process of normalization," said John Stoltzfus, chief market strategist at Oppenheimer Asset Management.

Stoltzfus said a selloff in bonds could feed on itself as investors seek redemptions from bond funds. Analysts worry that the housing recovery could be a casualty of interest rates that run too fast, if mortgage rates abruptly move higher.

But most strategists do not see the 10-year yield leaping wildly ahead.

"We have fair value of 3.5 in the 10 year," said Jack Ablin, chief investment officer at BMO Private Bank. "I don't think that's enough to roil the markets, roil the economy. The banks will certainly benefit, encouraging them to come back to traditional borrowing and lending."

Even as the Fed steps back from its QE program, it has stressed that it will keep short-term rates low for a long time.

4. Slowing profit growth: Earnings season gets underway in mid-January, and that may be the first test for stocks.

"Probably the biggest risk on the radar screen are the markets themselves," Ablin said. "Come the second or third week in January we start looking at earnings results, and we could see managements with downbeat forecasts. In that environment, where we're at an all-time high in just about everything, I think that's really going to be our first test."

Margins are at a cyclical peak of about 10 percent, and he expects earnings to grow just about 3.5 percent next year.

"The question is are we going to be able to maintain margins?" Ablin said. "Are we going to accelerate profit growth?" The low interest rate environment has helped companies with margin expansion, he added.

Citigroup's Levkovich said weaker earnings growth is certainly a risk, but there's also a risk that earnings could surprise to the upside.

"Earnings could come in stronger. There's more operational leverage in business than people perceive," he said. "Margins are really high because companies have been efficient."

Levkovich points out that only two of 10 sectors have higher margins than they had in the last earnings peak in 2007.

"Eight are meaningful below—there's operating leverage to the upside," he said, adding that lower tax rates and interest rates have helped margins.

Levkovich has a target of 1975 on the S&P 500 for 2014, recently raised from 1,900 based on expectations that profits will help drive it higher.

3. Inflation: As the Fed begins to step away from quantitative easing, the expectations for inflation have fallen along with commodities prices. But a number of analysts worry that the economy could strengthen enough to stir up inflation, even as the Fed tries to keep rates low.

"Just a perception within the market that the economy is doing well enough and there could be a reason to justify higher interest rates with a projection of higher inflation—that could give us a spike [in rates]," Stoltzfus said. "We've had two generations of investors right now that have never felt a bad bond market."

2. Washington: The debt ceiling debate could pick up steam in the coming weeks, but even though it is on the short list of worries, most strategists do not see Congress going to the brink again.

"It could be political dynamics that people start worrying about again as we move toward the middle of the year," Levkovich said. "There are a variety of factors, but I think Washington's always an interesting place to watch."

Both parties were blamed for the government shutdown, and he said it is unlikely the Republicans would risk the mid-term congressional elections with a big debt ceiling battle.

1. Geopolitical risks: Overseas threats are always a concern, and Levkovich points out that there could be currency disruptions in emerging markets.

China's credit crunch also casts a cloud, but Stoltzfus said he expects the country to manage and add positively to global growth.

"It's exasperated by regulators, needing to curb bank lending," he said. "We think China is more a contributor than a risk factor."

"My key wild card is obviously Europe," said Ablin, adding that it needs to create some kind of stimulus to assure a synchronized global recovery.

The positive U.S. energy story is bullish for America, he said, but if it drives oil prices too low, it could cause disruptions in economies that rely on oil production, including Russia and the Middle East.



©2014 CNBC LLC. All Rights Reserved. Patti Domm.

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