With 2013 coming to a close, one of the most frequent questions we have received is, “What’s the encore?” The S&P 500 rose over 32 percent, the best return since 1997. Will 2014 result in profit taking or will there be continued follow through as investors deploy their cash?
A year ago, investors were looking at a lot of uncertainty with the pending government sequestration, increasing taxes (as you recall, the payroll tax was increased to 6.2 percent), as well as international questions with Europe and a possible slowdown in China. Those fears, at least by market perception, were put to bed as the Federal Reserve continued to hold interest rates down with their bond buying program. As the U.S. economy showed steady gains and the Fed signaled the end to quantitative easing, investors chased stocks higher and exited bond positions. In the last six months of 2013, over $175 billion left bond mutual funds but only $75 billion found its way into equity funds. We believe there is still a lot of cash to be deployed in 2014.
Against the Wind
2014 will be the advent of the Janet Yellen tenure at the Fed, a mid-term election, as well as the conclusion of QE3. We continue see slow improvement in economic data for the U.S. economy. Unemployment claims are trending lower (after a volatile month due to the holidays). Manufacturing data remains healthy, as reflected by this week’s PMI reading of 57 (a score of 50 or above signals strength). The U.S. consumer remained engaged into the end of the year as retail sales rose over four percent (primarily driven by double digit on line sales growth). Finally, the housing market is improving with prices rising and inventories falling.
What could derail the expansion? Rising rates. As the Fed unwinds its bond buying, we believe rates will continue to trend higher. Will these higher rates be a meaningful headwind to growth and equity returns? We don’t believe so. However, we will be monitoring closely.
Back for More
This brings us back to the first question: what does 2014 have in store after such a strong 2013? Looking at historic returns, equities revert to their averages. Since 1928, there have been 17 periods when stocks returned over 30 percent. The following year, equities averaged an 11 percent return and were positive two-thirds of the time (in line with historic annual returns). Therefore, this year, equity returns are going to be contingent on corporate profit growth and market valuation, which we believe are both constructive.
We hope you all have a healthy and prosperous 2014 and we look forward to seeing our clients and friends at one of our many Investment Outlook presentations over the next six weeks.
Our Takeaways for the Week:
- The retail investor remains skeptical of equities
- The U.S. economy continues to show steady improvement