10 Steps Forward, 1 Step Back! Comments on January Stock Market

stock-market-investment

US stocks as measured by the S&P 500 delivered a phenomenal 32.4% return in 2013. That was the 6th best year for US stocks since 1940. In January, US stocks fell 3.5%. We don't watch business news anymore, but judging from an increased volume of phone calls from clients, we presume that CNBC, Fox Business, CNN and MSNBC have categorized this modest decline as "an apocalypse." Our "dashboard" shows return numbers for US and International stock markets, commodities, currencies and bond yields. A lot of red YTD 2014, but all green at the end of 2013.

On January 2nd, we spoke on Bloomberg Radio about our expectations for 2014:

  1. US stocks would experience a 10% pullback in 2014. We didn't know exactly when or why - January, April, August? Triggered by Fed action, a bad jobs report or a terrorist action?

  2. We do know that when stocks rise fast and furious, a correction of 10% is totally normal & expected.

  3. We did not plan to aggressively sell stocks, as we expect US stocks to end the year higher by December. Why incur taxes, trading costs and slippage if we don't have to?

  4. However, we had already lowered our exposure to US stocks in December as we rebalanced - taking profits on US stocks, rolling the proceeds into bonds, commodities and emerging markets, all of which had done poorly in 2013 (in other words, selling high, buying low.)

So far this year, bonds have rallied, commodities and emerging markets still struggle, and US stocks are down slightly. We continue to ADD to commodities and emerging markets, even as other rush to sell. Why? Between 1981 and 2008, the number of persons worldwide living in poverty (less that $1.25/day income) dropped from 1.9 billion to 1.2 billion, even as the world population surged from 4.5 billion to 6.7 billion. In other words, 2.9 billion ADDITIONAL consumers, primarily from Africa, Asia and South America, joined the 2.6 billion consumers of the developed West and North America. Those consumers want cars, smart phones and refrigerators, which means that no matter the short term fluctuations, the long term trend in commodities (the source of stuff) and emerging markets (the source of consumers) remains higher.

All eyes on the US Federal Reserve

So why the short term anxiety? Is there a single investor on the planet that doesn't know US rates have to rise? The Fed aggressively bought long dated bonds (as much as $85 billion/month) over the last several years, which drove up bond prices and drove down bond yields. The Fed recently announced reductions in purchases (tapering) to about $65 billion/month. Investors seem to feel that this will immediately drive the US economy back into recession because of rising rates. Those investors rushed to BUY bonds, driving the ten year yield from 3% to 2.65% over the last month, which ironically makes the Fed tapering policy easier to accomplish. Thank you!

Investors' expectation of recession does not match facts. US GDP is at a record level, growing at a healthy 3.2% year over year rate in Q4 2013, and 6.5% higher than the previous records set right before the 2008-9 financial crisis. US unemployment is still high at 6.7% but trending lower. US corporations have record revenues, record earnings and record cash on the balance sheets. Rising rates depress stock market valuations, but S&P 500 earnings are expected to rise 8.6% in 2014 and 10.7% in 2015, which more that offsets the drag of higher rates.

Rising interest rates WILL keep returns on bond investments flat to negative for the next two years. After hitting a post 1945 low of 1.45% in July 2012, the yield on the US 10 year note doubled to 3.00% by December 2013, which dropped the bond price by 12% over 18 months. We expect the ten year to yield 4.5% by the end of 2015, which means another 9.6% price decline over the next two years. We have addressed this expectation by bringing our bond maturities to the 3-5% range (shorter maturity bonds are less interest rate sensitive than longer dated bonds) and going down in credit quality (corporate bonds and preferred stock have higher current yields, which again reduces interest rate sensitivity.) Last year, our investments in bond funds rose about 2% versus a decline of 2% in the Barclays Aggregate Bond Index. We expect to earn 2-4%/year on bond investments over the next two years.

The best advice we can give you

So many inquiries from our clients are prompted by something they heard on TV. We've said it before and we'll say it again, "Television is the worst place to get investment information." We ask our clients, "Who is CNBC trying to impress!" "The audience!" say our clients. "No," we reply. "CNBC wants to impress advertisers, because advertisers, not the audience, pay the bills." Advertisers want eyeballs, and CNBC delivers those eyeballs by making sure you are scared half to death every day. All of the tickers running this way, and the data updating that way, draws your eyes to the screen like a moth to a flame, no matter whether you're at the airport, in a bar, at the gym, in an elevator, getting your shoes shined. Every segment is a sensation, "What should you trade today!" In our opinion, good investing is about as exciting as good accounting - apply diligence and care, and you'll do just fine. Or hire us to apply diligence and care for you, and enjoy your life.