2013 Year in Review – Commentary
2013 Year in Review
by Richard Siegel, CFP®
Broadly speaking, 2013 can be summed up as an excellent year for equities, a poor year for bonds and commodities, a year of political turmoil, and a year of economic improvement. The U.S. stock market delivered its best return since 1997 and U.S. bond yields saw their most significant spike since 1994, causing bond values to reverse their long term upward trend. Being diversified in 2013 was obviously not the ideal, since almost every type of security with the exception of equities delivered flat or negative returns. However, as a rising tide lifts all boats, all of our clients enjoyed solid returns based on varying levels of equity exposure in their portfolios.
ACWI – Global Equities, AGG – U.S. Bond Market, DBC – Commodities
One would think that the continuous fiscal cliff debate, the Fed’s talk of tapering their QE program, the government shutdown, and Obamacare would have triggered economic and market Armageddon. Interestingly, just the opposite occurred; the stock market climbed the proverbial wall of worry as the investing public became desensitized to political uncertainty. Additionally, the economy gathered strength in the second half of the year, highlighted by major improvements in the unemployment rate, consumer spending, and overall GDP.
Globally, much of the world’s GDP has been generated from emerging market economies like China and India in recent years. 2013 marked significant economic improvement in the developed market countries, most notably in the United States, the Eurozone and Japan, mostly attributed to pent-up consumer demand and aggressive monetary policy. With the Eurozone’s recent emergence from recession and Japan’s aggressive Abenomics1, it is worth noting that the global economy is gathering steam heading into 2014.
- An economic plan named after Prime Minister Shinzo Abe, aimed at rescuing Japan from 15 years of deflation
U.S. Stocks were the frontrunner this year with the S&P 500 returning almost 30% due to an improving economy, strong corporate earnings, and multiple expansion (P/E ratio normalizing to historical averages). Foreign stocks delivered solid returns but lagged domestic equities. It is our contention that U.S. stocks have achieved fair value, while many foreign markets remain undervalued and represent more attractive valuations at this point. Currently, the forward P/E ratio on the S&P 500 is approximately 16, the global market in aggregate is approximately 14, and emerging markets bring up the rear at approximately 10X forward earnings.
ACWI – Global Equities, ACWX – World Stock Market ex-USA, SPX – U.S. Stocks
For many reasons including the economic backdrop, innovation, and the unattractiveness of cash and government bond investments relative to stocks, it is safe to hypothesize that we are in the middle of a long term up trend in equities, also known as a secular bull market. It is important to note however, that secular bull markets come with periods of uncertainty, volatility, and market corrections. As tactical asset allocators, it is our job to navigate the markets in order to limit the volatility, maintain a low risk profile and take advantage of attractive valuation opportunities.
During the 4th quarter, we rebalanced client portfolios, slightly reducing U.S. equity holdings and adding to cash positions and the safer Balanced/Hybrid investment category. 2013 was an unusual year in that there were no significant pullbacks in the stock market. If history is a guide, 2014 promises to be more volatile based on the mid-term election cycle and a lack of a 10% correction in over two years. Because we remain optimistic that stock prices have room to rise over the long-term, we will use any short-term market weakness as a buying opportunity.
Fixed Income Overview
2013 was a year of tremendous volatility in the bond market. Coming from such a low point in yields, it has been our belief for the last couple of years that rates really had one direction to move, and that was up. During the May – July timeframe, the 10-year Treasury yield saw its largest and most rapid spike in decades. The rise in rates was triggered by Fed Chairman Bernanke’s testimony on May 9th that economic conditions were improving and the Federal Reserve would soon begin tapering its large scale asset purchasing program. With the prospect of less demand for these securities, bond values dropped and rates jumped. Being mostly invested in short/intermediate corporate debt as opposed to long-term government debt sheltered our clients from significant losses during this period.
The chart below illustrates just how poorly long-term U.S. Treasury bonds performed as rates moved higher. During the year, we made aggressive changes to our bond holdings in order to protect against loss of principal while rates were spiking. Much of our clients’ assets were allocated to flexible/unconstrained and short-term corporate investments during this period of rising rates.
Flexible Bonds (Unconstrained), TLT – Long-term U.S. Treasuries, CSJ – Short-term corporate bonds
Based on global economic growth, the tapering of QE, and a normalization of yields, interest rates should continue to rise over the next few years albeit at a much slower pace than in 2013. Bonds remain an integral component of our asset allocation strategies for income and protection against the volatility of equities.
We are looking forward to 2014 and feel that our portfolio strategies are well positioned to capitalize on global growth.