It is an exciting new year, but let us take a moment to review the events that moved the market in 2013. There is no doubt that 2013 was an extraordinary year with an incredible stock market rally, but there is a lot that we learned in the process. In reviewing these lessons learned we can be better prepared for the year ahead of us. U.S. and the European Union worked tirelessly to pull their economies out of lingering recessions with varying degrees of success. Before we draw any conclusions about the success or failure of 2013, let us take a closer look at the Federal Reserve, Unemployment, U.S. Markets, REITs, Commodities, and International Markets.
Key Takeaways:
Overall, there are some key lessons that we need to remember for the coming year.
1) Turbulence: The financial markets experienced turbulent times in 2013 and a great many investors stayed in cash for stability while others moved in the other direction by moving from the safety of bonds to riskier investments such as junk bonds.
2) Upside: Some asset classes lagged behind others in terms of upside. We will discuss this further in coming paragraphs.
3) Labor Statistics: Although the overall unemployment rate has improved, there are still reasons for concern when we take a closer look at labor statistics.
4) Emerging Markets: Not all international markets are created equal, as we saw in how much individual emerging markets differed in terms of performance.
Federal Reserve
Chairman Ben Bernanke of the U.S. Federal Reserve (Fed) stayed the course this year. For the 5th consecutive year their easy monetary policy sought to pump money into the economy by buying bonds. This included a $45 billion monthly purchase package of long term treasury bonds and a $40 billion monthly purchase of mortgage backed securities. The goal of the Fed this year was to lower the cost of borrowing money, with the intention of enabling economic growth and lowering unemployment as much as possible. In addition to creating jobs, the Fed is responsible for stabilizing prices and has set a target inflation rate of 2.0%.
In analyzing how their goals have panned out, we can conclude the following:
- Chairman Bernanke’s assertion that monetary policy alone cannot achieve the desired results is correct. Government fiscal policy needs to work in conjunction with the policies of the Federal Reserve. The main barrier to this is political, as the shutdown of the federal government in October showed clearly.
- The current inflation rate ended the year well below the 2.0% threshold, around 1.2%. A rate persistently below its 2 percent objective could pose risks to economic performance.
- The Fed is not the problem, but it can only be a part of the solution.
Unemployment
Unemployment has been one of the biggest drags on the economy since 2008, but there are some encouraging statistics as well as some disconcerting ones:
- The Unemployment rate is declining steadily. According to the Bureau of Labor Statistics, the arc of unemployment has ranged from 5.0% in 2007 to 10% in 2009 before gradually declining to its current level of 6.7% in December 2013.
- This must be regarded in the proper context. This percentage is calculated by taking the number of people who are looking for work but cannot find a job. Those who are not registered for unemployment, have had their benefits expire, or are no longer looking for work are not included in the unemployment rate.
- There is a very real problem in labor participation. A study by the Heritage Foundation titled Not Looking for Work: Why Labor Force Participation Has Fallen During the Recession takes this on. The study concludes “Today, 5.7 million fewer Americans are working or looking for work. This drop accounts for virtually the entire reduction of the unemployment rate since 2009—those not looking for work do not count as unemployed.”
Looking Back at 2013
United States Markets
Taking a close look at the U.S. Stock Market uncovers some interesting facts:
- It was a big year for big stocks. The U.S. stock market was up over 32% in 2013 as measured by the S&P 500 Index of 500 of the largest and most actively traded stocks in the U.S.
- Stocks pursued a steady climb, which came as a surprise to those who expected a sharp correction as prices zoomed ahead of earnings.
- There were conflicting headlines in the media during the year. CNN.money.com published The bull market Wall Street loves to hate while the markets were hitting an all-time high. This contrarian attitude made it a tough year for investors and advisors alike.
Opinions escalated this year regarding whether or not stocks were in a bubble. Some avoided this risk by holding in cash, especially the ultra wealthy. This was understandable given that there have been four asset crashes in the last decade. Dot-coms lost their investors 80% of their investment from 2000-02, and Housing dropped 35% from 2005-09 while Equity markets crashed 57%. Currently, Commodities are of the highest concern, down 30-50% in the last two years.
REITs and Commodities
This was not the year for REITs and Commodities, which were vastly outperformed by stocks in 2013. REIT investments in commercial property gained an unimpressive 1.75% on the year. Commodities were even worse, suffering a loss of -1.2% overall including a mind-numbing -28% plummet in the value of gold.
Bonds
Bonds are not as safe a bet as they have been in past years, and some investors have had to make tough choices to realize decent gains:
- Retirees and income investors are not realizing income because of historically low interest rates on bonds.
- Many investors have moved up the risk spectrum in search of higher yields, selling relatively safe bonds for dividend-paying stocks.
- Investment grade bonds lost money. Shorter maturity fared better than longer term bonds. High yield “junk bonds” were the big winner.
International Markets
Established stock markets in developed countries in Europe, Asia, and the Far east posted big gains while emerging markets struggled in 2013.
- The developed countries collectively gained 23.3% on the year
- Emerging markets in developing countries suffered a -2.6% loss in 2013
- Although developed markets’ bonds suffered a -3.2% loss this year emerging markets bonds were down -6.2%
Summary
2013 was an extraordinary year when the actions of the federal reserve has a huge impact. The question we will need to answer in the next year is how the Federal Reserve’s decisions will effect the market in the event that they reduce the buying of bonds or tighten their monetary policy. If the economy maintains its velocity when his stimulus is scaled back, the growth in earnings will support the prices that investors were willing to pay in 2013. This will be a big year of transition for the Federal reserve. Chairwoman Janet Yellen has her work cut out for her as she takes on a very large role in reducing bond purchases in a scaled plan designed to minimize disruption to the markets.
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Sources:
Sources of returns for the asset classes in this financial market review: S&P 500 TR Index, Morningstar SEC/REIT TR Index, S&P GSCI TR Index, iShares Gold Trust ETF, MSCI EAFE Index, MSCE EM Index, Barclays Global Trsy Ex US Index, JPM Global Core TR Index.