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Why the market could see a 17% drop in 2014

Monday, 30 Dec 2013 | 1:14 PM ET

Politics and the stock market always have had an uneasy relationship, but things could get especially messy soon.

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As the second year of the presidential election cycle approaches, market watchers are bracing for a period likely to be significantly more disruptive than the relatively calm sailing Wall Street saw as gains approached 30 percent in 2013.

While there are a slew of potential catalysts for a substantial correction, one that stands out is the presidential cycle. (This study from Pepperdine University helps spell it out.)

While the cycle has been a less effective signal in recent years, it is still a popular barometer used to predict market moves.

Lee expects another double digit stock gain in 2014
Thomas Lee, chief U.S. equity strategist at JPMorgan, told CNBC Monday, why he thinks there's a 1 in 3 chance that stocks can repeat this year's gains in 2014.

Simply stated, the cycle indicates that the market tends to perform less well in the two years following a U.S. presidential election and better in the years leading up to the next one. Obviously, 2013 did not confirm the presidential cycle, with its 29 percent gain in the S&P 500.

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More particularly, the second year of the cycle—the year when midterm elections are held—tends to be volatile, with substantial pullbacks, corrections or outright bear markets not at all uncommon. The typical return during such years is just 5.3 percent, or barely half the norm.

Corrections tend to be particularly violent, which is why the otherwise relentlessly bullish forecasters at Piper Jaffray are issuing a warning that while the market should post decent gains in 2014, it won't be without some turbulence.

The firm points out that since 1930, pullbacks during midterm years have averaged 17 percent.

"However, we believe that this pullback will unfold post the achievement of our next price objective of 2,000 on the SPX index in early 2014, and that (the) market will be higher by year's end," Craig Johnson, technical market strategist at Piper Jaffray, said in his weekly report for clients.

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"We suspect 2014 may be a good, but not a great year for the broader market (high single-digit to low double-digit return), with a higher level of volatility, and that relative strength-based sector exposure will be key to outperformance."

Johnson was well ahead of the bulls throughout 2013, predicting a 1,850 target for the S&P 500 early on while most of his fellow strategists remained relatively cautious about the market.

That 2,000 target has remained intact throughout, and he is sticking to it despite prevalent worries that the market's 2013 run is unsustainable.

S&P Capital IQ also has cautioned about the likelihood of a significant pullback even though it, too, remains broadly bullish. The firm also cites some history behind its belief that great years generally are followed by merely good ones that involve significant retreats along the way.

(Read more: Corporate deal-making ready to take off next year)

Since 1945 the S&P 500 has posted 21 annual gains of more than 20 percent. The average gain the next year was 10 percent, with the index up 78 percent of the time.

However, every one of those "good" years saw drops of at least 6 percent and up to 19.3 percent. Four of those years triggered new bear markets.

Market veteran Art Cashin at UBS told CNBC that a drop of 3 percent to 5 percent in January is likely, a prediction that if realized could be a troubling harbinger considering the month's consistent record of indicating the market's future path.

(Read more: Cashin: Expect a 3-5 percent correction next month)

"It's been a heck of a run, and it's time for a rest," he said.

—By CNBC's Jeff Cox. Follow him on Twitter @JeffCoxCNBCcom.

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