The fourth quarter capped a very strong year for stocks. Stocks in the U.S., as measured by the Standard and Poor’s 500, were up 32.4% in 2013, an astounding 173% higher than the bear‐market low set in March 2009. Small and value stocks, important tilts in our clients’ portfolios, were up even more than the broad market.
Foreign developed‐market stocks, as measured by the MSCI EAFE Index, were up only 23%, with gains in France, Germany, and Japan leading the way. Pro‐growth policies in Japan and relative stability in the Eurozone encouraged investors.
In contrast to the strong returns in developed country stock markets, emerging market stocks performed poorly in 2013 with the benchmark MSCI Emerging Markets index declining ‐2.3%. Rising interest rates in the U.S and other developed countries provided the catalyst for investors to withdraw capital from emerging economies. Additionally, weak commodity prices weighed on commodity exporters such as Brazil. Stocks in the U.S. and Europe were preferred, perceived to have an extra measure of safety.
One of the most closely followed stories this year was the Federal Reserve’s mid‐year announcement of potential “tapering”, a reduction of the $85 billion in monthly bond purchases intended to keep interest rates low and support growth in the U.S. economy. While the Fed indicated that the decision to reduce bond purchases was dependent on economic data, including a continuing recovery in employment, investors reacted by selling both stocks and bonds. As the year went on, investors became more accustomed to the idea of tapering and stocks resumed their ascent. Bonds stabilized at higher rates, creating small losses in the bond indexes. Interest‐rate sensitive investments such as real‐estate investment trusts experienced lower returns as well. The Fed’s decision to reduce bond purchases finally came in December, with a $10 billion monthly reduction slated for early 2014.
In 2013, one of the biggest themes was the healing power of monetary policy, and central bankers did not disappoint. Accommodative monetary policy continued in much of the developed world, supporting economies that have experienced lackluster growth since the financial crisis. In the U.S., a closely‐ watched indicator of economic growth, Real Gross Domestic Product, increased at an annual pace of 4.1% in the third quarter, above the 50‐year average of 3.1% (J.P. Morgan data). On the other hand, the employment picture has been a stubborn source of frustration. While the headline figure is much improved at 6.7% unemployment in December, some of the gains have occurred because more people are dropping out of the workforce. The dropouts occur for reasons as simple as retirement, or as demoralizing as discouraging employment prospects, but the bottom line is that fewer Americans are working. According to the Labor Department, the labor force participation rate of 63% is a 36‐year low.
The threat of deflation continued to plague developed economies in 2013. Deflation is a decline in the general level of prices in an economy, typically triggered by weak demand for goods and services. As prices decline, consumers are inclined to wait for even lower prices before making purchases. For example, if I want to replace my aging Ford Fiesta but see that the price of a new car declined $1,000 this year, I might wait until next year, hoping the cost will decline even more. This delay in buying can lead to lower corporate earnings, the underpinning for stock valuations. In the U.S., the Fed’s preferred measure of prices, Personal Consumption Expenditures (PCE), excluding the volatile food and energy components, was up 0.9% for the 12 months ending in November, according to the Commerce Department. This figure is well below the Fed’s target of 2%.
Fiscal policy, particularly in the U.S., was less predictable than monetary policy. Congress gave us plenty of things to worry about, including sequestration (an automatic reduction in government spending that began in early 2013), the debt ceiling debate, and the budget standoff. Most analysts expect that these fiscal policy missteps caused some reduction in U.S. economic growth in 2013; however, that figure was difficult to quantify.
It is remarkable that the U.S., a sovereign nation with reserve currency status that is able to meet its financial commitments, would allow the world to perceive that it may refuse to pay its bills, as happened this year with the budget debate. This stands in stark contrast to many of the peripheral European countries that would be unable to pay without the creative financing techniques backed by the European Central Bank (ECB). Leaders of the European Central Bank have assured investors that they will do whatever it takes to honor the financial obligations of Eurozone members, despite the fundamental inability to service debt. In addition to the ECB’s do‐whatever‐it‐takes attitude, a reversal of the hardline austerity measures imposed early in the financial crisis created a more tranquil investing environment in Europe. While it is easy to be lulled to sleep in this period of relative calm, the financial problems in Europe have not been solved and are likely to be a source of lingering uncertainty for years to come.
Economies in the emerging world faced many challenges in 2013. First, with meager growth in the rest of the world, developing economies have not had sufficient demand for goods produced for export. In addition, manufacturers in Japan have benefited from a weaker yen, making their high‐quality goods less expensive on the world stage. Third, Europe has consumed less over the past few years as consumers work through the ramifications of the sovereign debt crisis. All of these influences create a vicious cycle for emerging economies, one that can be broken with a broad‐based global economic recovery. Without substantial demand for exports, emerging economies cannot create the jobs necessary to develop their own middle classes. Without the rapid development of their own consumers, emerging economies must continue to rely on foreigners to import goods. With this cycle firmly entrenched, emerging economies could continue to suffer uneven growth, erratic capital flows, and ongoing social turmoil. With the International Monetary Fund predicting global growth of 3.6% in 2014, still below the preferred rate of 4%, the expansion of a global middle class could continue to struggle.
There is plenty to consider as we look ahead to 2014, but that uncertainty is always a part of the investing landscape. Maintaining a diversified portfolio with an appropriate risk level can eliminate the need to time the market, which, as history shows, is very difficult to do consistently. Capturing gains and containing losses within a well‐diversified portfolio can give investors what we believe is the best shot at achieving long‐term financial success.
Written by Colleen S. Supran, CFA, Principal; [email protected]
Key Economic Indicators
U.S. crude oil prices dropped 3.5% in the fourth quarter of 2013 due to an ample supply and stabilization in demand. Oil closed at $98.70. Return for the calendar year was 7.53%.
Key economic indicators compiled by Barbara A. Ziontz, CFP, Portfolio Manager; [email protected]
|Index||Market||Last 3 Months (10/01/13 – 12/31/13)||Year-to-Date as of 12/31/2013|
|Standard & Poor’s 500||Large Co. U.S. Stocks||10.51%||32.41%|
|Russell 1000 Value||Large Co. Value U.S. Stocks||10.01%||32.53%|
|Russell 2000||Small Co. U.S. Stocks||8.72%||38.82%|
|Russell 2000 Value||Small Co. Value U.S. Stocks||9.30%||34.52%|
|FTSE NAREIT Equity REIT||Real Estate Investment||‐0.17%||2.86%|
|NASDAQ 100||Technology Stocks||11.62%||34.99%|
|MSCI EAFE1||Foreign Stocks||5.71%||22.78%|
|Barclays Capital Aggregate||U.S. Dollar Bonds||‐0.14%||‐2.02%|
|Barclays Capital Municipal||Municipal Bonds||0.33%||‐2.55%|
|Merrill Global Gov’t Bond||Global Bonds||‐2.24%||‐6.79%|
Source: Thomson Financial’s Investment View
Data Sources: The Wall Street Journal; US Dept. of Commerce ‐ Bureau of Economic Analysis; US Dept. of Labor; Bloomberg.com; Live.Lehman.com; MSCI.com; REIT.com; NYTimes.com; StandardandPoors.com; Vanguard.com; Dimensional Fund Advisors
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