To say that 2013 was an interesting year would be a bit of an understatement. We learned a long time ago not to make predictions about the stock market because no matter what is predicted, it is likely to be wrong. Even if we get lucky one year, we are not likely to even get close the following year. We do try to give guidance, however. Last year we suggested that, given the late run in the market in 2012 and its 15% return, investors should be happy with a return of 8 to 10% in 2013. Obviously, investors enjoyed much better returns. The S&P 500 increased 32.39%, the Dow Jones Industrial Average increased 29.57%, the Russell 2000 Stock Index rose 38.8%, and the MSCI Index increased 22.78%, while bonds suffered their worst year in a long time with Barclays Aggregate Bond Index declining -2.03%.
We thought company earnings would slow during 2013 and that significantly higher stock prices were probably not warranted. Corporate earnings did increase modestly combined with slow economic growth and the markets surprisingly exploded higher. We felt that the Federal Reserve would begin cutting back on its $85 billion per month bond purchases sometime during the summer or early fall, but that didn't occur until the last Federal Reserve meeting of 2013. Third quarter GDP was up 4.1% and the fourth quarter of 2013 is likely to be much stronger than initially thought, supporting our view that the second half would be stronger than the first half.
The Federal Reserve determined that bond purchases through Quantitative Easing were needed in order to encourage job growth and the last four months of 2013 averaged 200,000 new jobs per month, in part due to that decision. In part because of this economic progress, the Fed finally decided at its December meeting that tapering was in order as they announced bond purchases would decline by $10 billion beginning in January, while still insisting they remained prepared to slow or hasten tapering depending upon future economic results. The Fed also stated that it will keep short-term interest rates at essentially zero even after unemployment falls below 6.5%. This was the sweetener that the Federal Reserve added to calm the markets, and they clearly accomplished their goal as the equity market increased during the latter part of December.
Before looking ahead it might be worthwhile to look back; all the way to last December and January. Congress and the President took the country over the fiscal cliff, and it wasn't until early January that they came up with a so-called solution. Much of that solution was to raise taxes on everyone, at least everyone who was working, reinstating Social Security tax rates to pre-recession levels and raising taxes on the wealthy to a top rate of almost 44%. The full impact of these tax increases, however, won't be completely understood until tax returns are completed and people are shocked at their tax bills. But we digress. Not more than a few months later, the economy and the American people had to endure the sequester deadline in March. This also went to the very last minute and, since Congress could not come up with an answer, sequester came into play. This was the “nuclear option” that neither the Democrats nor the Republicans ever thought would actually occur.
In May, Federal Reserve Chairman Ben Bernanke whispered about the possibility of tapering, and we saw a huge negative reaction by the equity markets and interest rates on the 10 year US Treasury note spike from 1.6% to 3%. This jump in bond prices was unprecedented in such a short period, causing the Fed to quickly deny an early end to bond purchases. When the Fed did not begin tapering in September, deciding instead to provide continuing financial stimulus to the economy, investors were finally convinced that the Fed would taper later rather than sooner and as a result, the markets moved dramatically to the upside.
In October, Congress once again scared us by allowing the government to shut down and walk to the brink of debt default. Ultimately, they only put a Band-Aid on the problem and pushed off dealing with the debt ceiling until February.
In December, in a rare display of bipartisanship, Congress passed the budgets for 2014 and 2015, a minor compromise, but significant nonetheless.
Finally, we experienced a regulatory first. On the same day, five regulatory organizations (Federal Reserve, FDIC, Comptroller of the Currency, SEC, and Commodity Futures Trading Commission) passed the so-called "Volcker Rule". This rule, named after former Fed chairman Paul Volcker, is designed to keep banks from making risky, a/k/a gambling, moves for their own accounts, which could jeopardize their capitalization. Many banks have already sold off or separated their trading operations in anticipation of this rule.
The Fed finally started the tapering in December, the same month that it celebrated its 100th birthday, and it proved to be a non-event. Goodbye to 2013!
Hello 2014! For those of you who don't want to read the rest of the bullets we’ll give you our top nine thoughts for 2014 in no particular order:
1) The economy should expand at a faster pace than last year resulting in positive equity returns and continued pressure on bond values.
2) The Fed will cease its Quantitative Easing and tapering is completed by the end of 2014.
3) 10 year Treasury rates rise to well above 3% but remain historically low.
4) Inflation remains below Federal Reserve objectives due to a weak labor market, lower energy costs, restricted bank lending, and commodity price weakness.
5) Job growth continues, but many job opportunities are for lower skilled workers. But jobs – any jobs – are better than none.
6) Pent up demand for capital goods will spur business investment, which has been lagging.
7) Continued dysfunction in government, coupled with mid-term elections in November, will result in little legislative progress.
8) Volatility will increase, presenting challenges and opportunities.
9) Overseas developed markets may offer better opportunities than the last several years but increasing interest rates could pressure most emerging markets as the dollar strengthens.
The bull market continued unabated during 2013 and we have now gone 58 months since it began on March 9, 2009. The total return for the S&P 500 since that time has been approximately 200% with dividends reinvested, which represents an average annual gain of 25.8%. Since 1950, the average bull market has lasted approximately 57½ months; but this one shows few signs of being tired.
For the past five years this market has been driven in large measure by the Federal Reserve which lowered short term interest rates to near zero in December 2008 and has sustained those interest rates since. This allowed some companies to grow their stock prices more through “financial engineering” than earnings growth.
In 2014, the markets must stand on their own, with companies producing increased sales and earnings to justify higher prices. This leads us to the question of, "are we in a bubble?" In our opinion, the market is not in bubble territory. We are at the upper end of an average P/E, but not dangerously so, particularly given low interest rates and low inflation. As of November, the P/E for the S&P 500 on a trailing basis was 16.8 which is 5.6% below its median of 17.8, and the S&P 500 is only trading at 14.9 times next year's projected earnings.
Fixed income investors face greater challenges as our call for interest rates to rise will necessarily mean bond prices will fall. The effect can be mitigated, in part, by shortening maturities and by diversifying credit quality.
We continue to expect a market “correction.” A 10% correction hasn't occurred since late in 2011, and it is possible to have this type of correction at any time. Based on information available today, we would view a correction as a buying opportunity. There are typically three pullbacks of 5% or more in any healthy year of a bull market. Because of all of the cash on the sidelines these pullbacks may be sharp but shallow as investors try to take advantage of the declines in the market. We don't see a fundamental change in the economy at this point, but it is always the punch you do not see which knocks you out.
Geopolitical risk is still a concern and can’t be predicted. The Middle East remains a significant risk despite the Administration’s diplomatic efforts. At the same time, Africa is beginning to boil over in many places, most notably in Egypt and Sudan. Of course we can't discount the political atmosphere in Washington, which we've already said is likely to be contentious in nature, especially as we get close to the November elections.
It is foolhardy to think that 2014 market returns will be like 2013, but great years are often followed by good years. Since 1945, the S&P 500 gained 20% or more 21 times and was followed the next year with a positive market 78% of the time. The average for all 21 the following year was a gain of 10%. Should we be fortunate enough to get that 10% return in 2014, we will take it!
Some definite “don'ts” that all investors need to heed: don't chase returns; don't second-guess the markets; don't change your asset allocation if it meets your risk profile; don't try to time the markets; don't be a trader; don't listen to the talking heads; and don't panic when the market goes down. This is some of the best advice the ProVise professional team can give you with our combined 225 years of financial planning and investment management experience.
Please know that all of us here at ProVise are here to serve you in any way that we can. Should you have any questions or require additional information, please don't hesitate to give us a call. We appreciate the confidence you have placed in us through the years and look forward to that relationship continuing a long time. Happy New Year!
As always, we encourage you to give us a call if you would like to discuss anything further. We will visit again soon. Proudly and successfully serving our clients for over 27 years.
RAY, KIM, ERIC, BRUCE, LOU, NANCY, TINA, JON, STEVE and DOROTHY
© 1/2/14 ProVise Management Group, LLC
This material represents an assessment of the market and economic environment at a specific point in time. Due to various factors, including changing market conditions, the contents may no longer be reflective of current opinions or positions. It is not intended to be a forecast of future events, or a guarantee of future results. Forward looking statements are subject to certain risks and uncertainties. Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by ProVise), or any non-investment related content, made reference to directly or indirectly in these Bullets, will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in these Bullets serves as the receipt of, or as a substitute for, personalized investment advice from ProVise. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Information is based on data gathered from what we believe are reliable sources. The information contained herein is not guaranteed by Provise Management Group, LLC as to accuracy does not purport to be complete and is not intended to be used as a primary basis for investment decisions. The indices mentioned are unmanaged and cannot be directly invested into. ProVise is neither a law firm nor a certified public accounting firm and no portion of these Bullets should be construed as legal or accounting advice. A copy of ProVise’s current written disclosure discussing our advisory services and fees is available for review upon request. If you do not want to receive the ProVise Bullets, please contact us at:[email protected]or call: (727) 441-9022. Please visit our Web Site at:www.provise.com.
Dow Jones Industrial Average - The Dow Jones Industrial Average is a popular indicator of the stock market based on the average closing prices of 30 active U.S. stocks representative of the overall economy.
S&P 500 Index is an unmanaged group of securities considered to be representative of the stock market in general. You cannot directly invest in the index.
