Nola Kulig
Kulig Financial Advisors
Longmeadow, MA, 01116 USA
413-565-2839
Add to Contacts

2013 Markets Review

January 31st, 2014

What a difference a year makes! Early in 2013, things were incredibly unsettled: markets continued to teeter based on the most recent news from Europe, we had just “gone over the fiscal cliff,” we all wondered what the impact of the sequester would be, Congress was always divided on some issue . . .   the list just went on and on. There was either macroeconomic or political fodder for nearly every newsletter or blog post penned  last year, which tended to crowd out discussion of personal finance topics. For that I apologize, but this was the hand we were dealt.

So if it didn’t feel much like we should be having a roaring bull market, you are certainly to be forgiven. But many factors began to turn more positive. The economy sidestepped the fiscal cliff, and without this stiff headwind, stocks roared out of the gate, producing their best year since 1997, according to data provided by the St. Louis Federal Reserve. Domestic mid- and small caps performed even better:

Market Returns

Market

Index

December

Q4 2013

YTD
12-31-2013

Stocks        
Large Cap S&P 500 Index

   2.5%

10.5%

32.4%

Midcap S&P Midcap

3.1

8.3

33.5

Small Cap S&P Small Cap

1.5

9.8

41.3

Non-US Developed Markets MSCI EAFE

1.5

5.7

22.8

Emerging Markets MSCI Emerging Mkts.

-1.5

1.8

-2.6

US Bonds Barclays US Aggregate

-0.6

-0.1

-2.0

REITs S&P US REIT

0.2

-0.7

2.4

MLPs Alerian MLP

1.6

5.3

27.6

Gold Dow Jones-UBS Gold Sub index Total Return

-3.8

-9.5

-28.7

Commodities Dow Jones-UBS Commodity Index TR

1.2

-1.1

-9.5

Sources: AJO Partners, Factset, Dow Jones Indexes

Many are asking, “Why did we have a ferocious bull market when the economy is still limping along?” It’s a great question. The short answer: 2013 was a year where the bad news was good news.

First, the economy has been limping along since it officially emerged from the Great Recession in 2009. With job growth in low gear and inflation even lower, the Federal Reserve embarked on a series of bond purchases, popularly called quantitative easing, or QE for short. Remember, by definition, rising bond prices equate to falling yields. The Fed’s goal? Put downward pressure on yields in the hope consumers and businesses would borrow and spend, sparking job growth.

Reviews on the effectiveness of QE have been mixed, but one thing seems certain: the Fed’s ultra-easy monetary policy has been a boon for the stock market.

Second, we should not discount the impact from rising corporate profits. According to Thomson Reuters, earnings per-share for S&P 500 companies hit a record in the first quarter of 2013, and subsequently broke that record in the second and third quarters.

Moreover, analysts are forecasting another high in the fourth quarter. True, economic growth has been substandard, but very modest revenue gains, coupled with highly controlled expense management, have been a tailwind for profits.

Third, companies have more cash than they know what to do with, at least the major corporations. Given heightened levels of economic uncertainty and few opportunities to expand, companies are buying back stock (or borrowing at record low interest rates to finance purchases).

Yet it is not just the repurchases of shares that count, but whether companies are also selling new shares to the public. Howard Silverblatt, senior index analyst at S&P Dow Jones indices, summed it up well in December when he said, “We are starting to see excess buying, where the repurchases outnumber the issuance, and therefore, reduce the share count. The lower share count leads to higher earnings per share, and the market likes higher earnings per share.”

While the repurchase of company stock has underpinned the market, dividends have also sweetened the pot. S&P Dow Jones Indices estimates that companies returned a record $310 billion last year in the form of dividends.

Finally, although we cannot truly call this a tailwind, Europe has quieted down. Banking woes have not been put to rest, but the vicious headlines that swirled across continents creating uncertainty in the US, especially in 2011, were mostly absent last year. Think of it like the fiscal cliff – for now, a hurdle removed.

Bond Market: Dancing to a Different Tune

Early gains in treasuries were replaced by jitters that QE was on the verge of being reduced by the Fed, and Treasuries responded accordingly. The 10- year treasury yield which began 2013 at 1.70%, ended at 3.04%. (Note that rising yields did little to slow the equity juggernaut.)  At the December meeting, the Fed finally announced it would reduce the $85 billion in monthly bond buys by a modest $10 billion, with promises of more cuts in 2014 if the economy cooperated.

Meanwhile, losses in corporate bonds were more muted, and high-yield debt, which hit a pocket of turbulence in the middle of the year, outperformed most bond classes. That shouldn’t come as a surprise, since an expanding economy has historically lent support to firms with lower credit quality.

Setting Expectations for 2014

It’s never productive to make predictions, especially about the markets. And as my clients know, we design portfolios with the objective of avoiding being dependent on any single market scenario; instead, we diversify to make your portfolio more resilient in different market environments which no one can predict accurately in advance. With that in mind, we will cautiously look at possibilities for 2014, using history as a guide.

Everything that drove stocks to new highs in 2013 remains in place: extremely low interest rates, expectations of further growth in corporate profits, and the belief that companies will continue to return cash to shareholders. Further, any acceleration in economic activity that might reduce QE could be supplanted by rising corporate profits, which might shoulder more of the heavy lifting for the stock markets.

Having said that, it is unlikely that we will have as spectacular a year for the US stock market as we did in 2013. Will they continue to rise, even if it is at a more moderate pace? Although some analysts are optimistic about US stocks this year, others think that US equity prices are no longer cheap. Yet few are calling for significant declines.

But it’s never really clear. Questions being asked include:

What will the Fed do? Will the shallow recovery in Europe take root, or will banking woes resurface? Will China continue to grow or is an economic hard landing inevitable?

Could we see new problems surface in the Middle East? Historically, geopolitical headwinds have proved to be temporary, but that doesn’t eliminate the possibility of heightened uncertainty over the short term.

On a more positive note, will faster capital spending occur, supporting the economy? And how will the energy boom continue to underpin growth?

Portfolio Implications

You’ve heard this before from me: no one can accurately predict the future. A search for the proverbial crystal ball over a long career in finance has come up dry. (Although I do have one in my office–a gag gift from my husband.)

Could we have a correction and see the major averages decline by 10 to 15% or more? It’s always possible. Corrections have a way of catching the consensus off guard, creating unwanted anxiety.

Yet most of the time we need not be overly concerned. Besides, washing out excess optimism can set the stage for further gains. Here are some key things to remember as events unfold this year:

  • You need to be comfortable with the risk level of your portfolio.
  • There’s always some uncertainty when investing.  As we discuss in our meetings, our goal is to help you mitigate that risk. But you must be comfortable with the level of risk you’re taking as we set out to meet your objectives. If you are not, it’s time to recalibrate.
  • Stick to your plan. Markets rise and markets fall, but unless there have been changes in your circumstances or you hit milestones in your life, such as retirement, stay with the plan. For example, it was tempting to cash out of stocks in 2009, but hindsight has proved that would have been costly.
  • Rebalance. Last year’s surge in equities may have taken your portfolio out of alignment with target stock and bond allocations. Now may be the time to take profits on winners and selectively reallocate proceeds into bonds.
  • Don’t discount international. Emerging markets have been underperformers over the last couple of years. The US may or may not outperform the rest of the world in 2014, but over the longer-term, exposure to global markets should be beneficial and help to reduce risk.
  • Don’t dump bonds. While prospects for returns look low, they continue to provide diversification and risk protection, especially if your time horizon is shortening as you age. You may want to take more of a defensive strategy with bonds, but they still play a key role in portfolios.

 

Investment advisor representative of an investment advisory services offered through Garrett Investment Advisors, LLC, a fee-only SEC registered investment advisor. Tel: (910) FEE-ONLY. Kulig Financial Advisors may offer investment advisory services in the state of Massachusetts and other jurisdictions where exempted.