What You Can Expect in 2014
There are many sayings that could be apropos for markets in 2014. Of course we have all heard the old, trite expression, “Expect the Unexpected.” However, I like Oscar Wilde’s take. “To expect the unexpected shows a thoroughly modern intellect.” So, I won’t tell you not to be surprised when the unordinary occurs, but I’d like to think we have thought through most of the scenarios good and bad for 2014 and would have an answer for them all. I will take a stab at some expectations we at HMC Partners have for 2014. The markets will have more than one sell-off in 2014 of 5% or more. According to LPL Financial’s Chief Market Strategist, Jeffrey Kleintop, this market saw only one pullback of 5% or more in 2013 when an average year sees four or more.1 With increased number of pullbacks that could be above 5%, volatility will return to markets. As of 1/6/2014, the Volatility Index (VIX) is around 13. For frame of reference, the VIX five-year average has been approximately 40. This low volatility can lead to complacency and can cause an over-reaction in the other direction when bad news comes calling.
Speaking of bad news, with Syria, Turkey, and Iraq providing so much strife in the Middle East, it seems unlikely that something pessimistic would not result. Any real or perceived interruption in oil flow we believe will have immediate negative impacts on gas prices. Higher gas prices typically result in lower earnings and higher prices passed on to consumers.
We believe this year could be another good one for equity markets. What the 1990’s boom and last year had in common were the same type of low inflation and moderate GDP and job growth. Low inflation kept in check by moderate economic growth is much to Wall Street’s ears. It probably would mean the Fed could taper and not be forced to raise rates.2
In our opinion it is getting close to time to buy emerging markets again. This area is historically either a big winner or as in last year, a loser with near zero returns for the index. Cyclically Adjusted Price to Earnings Ratios for Emerging Markets or CAPEs is now at 10, as of 1/6/2014. Typically when CAPEs are this low, the timing is good for a good cycle for these types of stocks. Portfolio managers may seek to move higher priced US stocks out preferring less expensive EM’s for growth purposes.3
Having an undiversified portfolio served those well willing to take that kind of risk in 2013, but diversified holdings based on your risk tolerance will again make sense in 2014. Whether you used precious metals, traditional bonds, emerging markets or some other form of diversifying tactics, owning US stocks was what helped you realize better gains. Look for a return of more true and tried methods of allowing for growth that the amount of equities you own provides while not being whipsawed by defensive pieces in your portfolio.1
Finally, Washington is bound to disappoint. While the agreement reached towards the end of 2013 was important from a Public Relations standpoint, truth be known it really did very little to tackle the major issues that our polarized lawmakers have metastasizing. Look for these issues to exit remission as the calendar moves from winter to spring.
In general, we have prepared our clients for what we hope will be another good market year with a bias towards equities. With the 10 year treasury’s yield increasing, we see a pricing in of the first round of interest rate hikes that could be more than a year away. We still believe in diversified portfolios utilizing techniques of modern portfolio management. We will expect the unexpected, but really believe that if you expect it then it’s not unexpected anymore. That’s how we like to prepare your portfolios.
(1) “Weekly Market Commentary – The Stock Market’s Favorite Season.” Jeffrey Kleintop, CFA, LPL Financial Chief Market Strategist. 1/6/2014. http://lplfinancial.lpl.com/Documents/ResearchPublications/Weekly_Market_Commentary.pdf (2) “Will the U.S. bull market continue?” Reuters. John Wasik. 1/6/2014. http://uk.reuters.com/article/2014/01/06/column-wasik-idUKL2N0KG13P20140106 (3) “How to overhaul your portfolio for 2014”. The Wall Street Journal. Burton Malkiel. 12/30/2013. http://online.wsj.com/news/articles/SB10001424052702303345104579284603227774012 • The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. • No investment strategy can guarantee success or protection against loss. Investing involves risk, including loss of principal. • Investing in specific industry sectors may be subject to greater volatility. • International and emerging market investing involves special risks such as currency fluctuation and potential instability and may not be suitable for all investors. • Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. • There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. • The economic forecasts set forth in the presentation may not develop as predicted.