MARKET-VIEW 4TH QUARTER 2013 – January 2014 Newsletter

After a great year for the equity market in 2013, investors are looking to 2014 and wondering what to expect in the year ahead.  The economy appears to be gaining momentum as we head into 2014 and may soon enter “escape velocity” – meaning our recovery moves into expansion and does not require excess monetary stimulus (no quantitative easing) which could bring the expectations of tighter monetary policy into investors’ minds.  A secular bull market is likely intact but the risk of a 5-10% correction this year is elevated.

These gains came in the face of ongoing macro challenges, illustrating again that stocks often like to climb a “wall of worry”.  The past year started with a government crisis and an agreement regarding the fiscal cliff.  Throughout the following months we saw political problems in Europe, an international crisis in Syria, another US government shutdown, a botched rollout of the Affordable Care Act and the word “taper” entering our investment lexicon.  Stocks kept powering higher however, with only brief pauses along the way.

This bull market is now the 6th longest in S&P 500 history and also the 4th strongest in terms of total return (up cumulative 173% EOY 2013).  It was the 5th consecutive positive year for the S&P 500.  We’ve had only 2 other 5-year spans (’95-’99) and (’03-’07) and one 8 year span which was the longest (’82-’89).  The daily volatility was the lowest since 2006 with only one 5% correction.  It was only the 18th time in S&P 500 Index history with a price return over 25%.

Our blended US Equity benchmark return topped 33.3% in 2013.  The S&P 500 Index returned 32.3%, the S&P 400 MidCap Index returned 33.5% and US SmallCap gained the most with a 38.8% gain.   Our blended International Equity benchmark return finished the year +11.7%.  Developed markets (MSCI EAFE Idx) easily beat emerging markets (MSCI EM Idx) returning 19.4% for the year vs. negative 2.6%.  Our Hybrid blended benchmark ended 2013 with gains of 7.3% led by Infrastructure (16.8%) and Hedge Fund (8.8%) which was countered by losses in Alternative Income (-0.98%) and Hard Assets (-1.2%).

Conversely, the US Bond market had its worst loss in 14 years and was down for only the 3rd time in the last 28 years.  Fixed income is an important anchor during market declines and volatility and our tactical under-weighting across Fixed Income, as well as our move into shorter-term bonds, helped limit clients’ downside.  The Barclays US Aggregate Bond Index lost just over 2% in 2013.

 

US Economic Outlook

We expect an acceleration of economic growth, led by a declining fiscal drag (government not pulling down GDP as much). Continued strength in housing and a pick-up in business capital spending should correlate well with job growth.  The US economy is being powered by consumer spending, business investment, housing and job growth.  Improved sentiment and leading indicators suggest a coming rebound in capital spending which is complemented by robust corporate cash balances.  We believe 2014 will see a continued uptrend in equities but anticipate more pullbacks along the way (more volatility this year vs. 2013).  There is a glimmer of hope around political dysfunction with the recent budget agreement; albeit not anything resembling the “grand bargain” some might hope for.  US Federal Reserve (Fed) tapering should continue to be on the minds of investors. However, low inflation puts little pressure on the Fed to act aggressively and the futures markets show an “anchoring” of short-term rates at least through mid-2015.  If the unemployment rate drops more quickly than expected and US economic growth is stronger than expected, it could have negative implications for inflation. If this were to occur, tighter monetary policy and increased interest rates could be the catalyst for a sharper correction this year.

 

Global Economic Outlook

Global growth is expected to strengthen in 2014 with leading economic indicators from most developed countries and new orders in global manufacturing PMI’s hitting multi-year highs.  These are clear signs of improvement in most major economies.  The IMF (International Monetary Fund) is forecasting global growth of 3.6% in 2014 which is an improvement over 2013 growth of 2.9% and 2012 growth of 3.2%.  Europe improved dramatically this past year thanks in large part to European Central Bank (ECB) President Draghi’s “do whatever it takes” policy and the subsequent conditional bond purchase program that provided a “safety-net” that restored confidence and thawed credit markets.  Labor reforms in Spain, Portugal and Ireland improved competitiveness and the fiscal drag across Europe decreased in 2013.  There are obstacles to growth however, and the modest recovery has yet to become self-reinforcing.  We remain positive on European stocks because valuations are low and profit margins are depressed and possibly at an inflection point.  There could be additional volatility in the first half of 2014 related to whether and how the ECB further eases.

 

Looking Ahead

Market Indicators 2013

It would be foolish not to be mindful of complacency given valuations have moved sharply higher over the past two years and investor sentiment (a contrarian indicator) is showing elevated optimism.  At this stage of the bull market there are few major warning signs of impending declines for 2014 (see chart to the right).  Consumer sentiment gives us the most worry heading into 2014.  If measures showing excessive bullishness continue to increase we may move to take more gains.  US equity mutual fund net Cash Flows ended 2013 in positive territory for the first time in 8 years.  The return of the retail investor is not necessarily a bad thing; however, their timing of such entry is usually a sign to be more cautious moving ahead.

In 2013 we saw investors move somewhat reluctantly into equities and we believe there will be more cash put to work throughout 2014.  Investors should heed the lesson that there is no perfect time to invest and often the times when it feels least compelling ultimately prove to be the most profitable.

We do expect the US marketplace to experience a decent pullback at some point during 2014, but we also believe stocks will ultimately end the year higher.  10-year Treasury yields will likely continue to move higher meaning moderate declines in fixed income values.  European equities look attractive and we are warming to certain emerging markets.   Japan faces some critical events that we will be watching closely while ex-China emerging markets could continue to struggle in 2014.

 

In Conclusion

Your end-of-year report from Clearview Wealth Management will contain your managed portfolio returns for the partial year net of our management fees.  Your blended benchmark return is driven by your specific Asset Allocation target.  We use industry standard indices to compare returns within each of our 5 asset classes[1].  Each client’s actual return versus their respective benchmark is further influenced by a multitude of client specific factors including but not limited to cash levels, cash flow needs, market timing, capital gain influenced holdings, and client driven holdings.

As your trusted advisor, Clearview Wealth Management works diligently to review and rebalance your portfolio as necessary as we continually assess the changing U.S. and global economic landscape for opportunities as well as risks that permeate the financial world. As always, keeping a longer-term perspective in mind as 2014 unfolds will require discipline in your investing strategy.  If you have questions please feel free to call us to discuss any of the topics above.

 

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Portions of information for this newsletter were sourced from Turn the Page: Outlook for Economy/Stocks in 2014 and Schwab Market Perspectives: Glance Back … Look Aheadby Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co, Inc.; 2013

 



[1] Blended Index Returns include the 3-month US T-bill rate for our Cash and the Barclays US Aggregate Bond Index for Fixed Income.  We use a blend of Hedge Fund, Alternative Income, Infrastructure and Hard Asset Indices for our Hybrid Target.  The US Equity index is a blend of S&P 500 Index, S&P 400 MidCap Index and the Russell 2000 Small Cap Index.  Finally, we use a blend of the MSCI EAFE Index and MSCI Emerging Market Index for our International Equity Target.