Without a doubt, 2014 was a unique year in the investment markets. For many, the Dow Jones Industrial Average or the S&P 500 is considered to be “the market”. In years past, for U.S. investors, these two indices explained a great deal about not only the US economy, but also other markets around the world. However, in today’s world of global investing, especially with regard to 2014, it is helpful to look more closely at the various individual markets, as they all performed differently and may continue to have a dispersion of returns, even in this connected world in which we live.
Stocks:: The Ups and Downs of 2014
Coming off a roaring 2013 bull market in both the U.S. (S&P 500 up 32.4%) and internationally (EAFE up 23.3%), optimism was generally pretty high for 2014. However, some felt that higher valuations after a 5-year bull market were sure to result in a “correction” of some sort. As the first quarter rolled around, inclement weather took a major toll on U.S. earnings, causing the bears to come out. As the year progressed, the U.S. economy regained its momentum, with both the earnings and employment picture brightening. Overall, 2014 served as a good reminder that markets fluctuate quite a bit throughout the year as investors digest and interpret new information on a daily basis.
We saw multiple periods where the market went down quite quickly day after day … only to later reverse course in an often-similar speedy manner. This dramatic fluctuating was most notable in small and mid-sized U.S. companies. As an example, one episode in late September experienced over a 9% sell-off in a few short weeks. While the overall economic backdrop for the U.S. seemed to brighten as the year went on, this was not uniform across all sectors, as utilities performed the best (up 28.09%*) while energy related stocks ended the year down (-9.27%*), due to a dramatic sell off in oil prices in the 4th Quarter.
The developed international markets continued with positive returns in the first half of the year, but slowing economic growth and mounting deflation fears resulted in negative returns for the year. Emerging markets, which performed poorly in 2013, continued a steady and slow decline throughout the year, with fears of a slowing China as a major driver. One huge story this year that received little press was the strengthening of the U.S. dollar. If simply measuring the international markets or emerging markets in their local currencies, all of these markets actually experienced decent positive returns; only after accounting for the devaluation of their currencies against the rising dollar did the results turn negative. This dramatic strengthening of the dollar could create a large tailwind for Europe (whose exports just became very cheap) and a headwind for the U.S (our exports become more expensive).
One larger “market” that rarely makes headlines is the bond market. 2013 ended with the 10-year U.S. Treasury bond losing -7.8%, resulting in a yield of 3.04%. Much of the talk earlier in 2014 focused on the potential for interest rates to rise as the Federal Reserve finally ended its unprecedented quantitative easing (QE) program. We had a precursor to the market’s potential reaction to the Fed stopping QE in mid-2013. Many felt like rates were more likely to rise than fall, as they were still near historic lows at the start of the year. However, rates actually declined in 2014 as global fears, low interest rates overseas, and currency issues reiterated the attractiveness of U.S. Treasury bonds. For investment managers like ourselves, who view bonds as the “safe side” of the portfolio that we count on for stability, most of our allocations held a reduced-exposure to bonds, in order to protect against the potential interest rate increases. Further rate decreases were not anticipated. Unfortunately, lack of exposure in intermediate or longer maturity bonds was a detractor from performance in 2014, as the 10-Year U.S. Treasury gained 10.7%. Other bond types, such as corporates and high yields, experienced lower appreciation, with the U.S. Aggregate Bond index up 5.97%. Short-term bonds and some of the unconstrained bond funds included in our allocations experienced returns that were closer to flat for the year as well.
2015 and Beyond
While reflecting on previous years’ results is helpful, the real questions are what do we expect in 2015 and beyond, and how should we be positioned for the future. At Bridgeworth, fundamentals and valuation are the building blocks of how we make investment decisions. There are no crystal balls and coin flips do not occur as we see daily events unfold. With that being said, our thoughts on the U.S. stock market start with the view that the risk of recession is pretty low, while economic growth will probably be similar to years in the recent past; not too fast and hopefully not too slow. This “Goldilocks” environment of slow growth and low inflation will probably allow the Federal Reserve to be very modest with any potential interest rate increases; if they raise at all in 2015. Current stock valuations of U.S. companies are slightly higher than historical averages, but this is not particularly troublesome since interest rates should stay low, helping to support above-average valuations. The general consensus is that the U.S. stock market will grow at a rate similar to that of corporate earnings in 2015. The longer we stretch our time horizon, we should expect lower average annual returns because of the “higher” valuation levels that are currently shown in the U.S.
Developed international markets in the nearer term are tougher to forecast, as a variety of factors, both positive and negative, are mixing together in what is already a fragile environment. Positive factors such as a weaker currency, which helps exporters in Europe, cheaper energy costs, and potential European Central Bank (ECB) action may combine with lower stock market valuations to provide a welcomed rally. However, deflationary pressures, structural problems, and the “Putin risk” may lead to poorer results. Remembering the following two thoughts helps us make tough decisions with regard to international investing. First, companies are not countries, and it’s important to separate the two. It is possible for a company domiciled in a struggling country to be a great investment. The second thought relates to time horizon. When we stretch the time horizon longer than just a year or two, the valuation picture helps to remind us that buying low is what provides the opportunity for higher future returns. It’s not fun to buy low and wait, but in the absence of a crystal ball, it’s often the most effective method.
Emerging markets paint a similar dilemma. There are near-term issues, such as low oil prices and slowing growth, which can impact these markets, but the valuations of many emerging market companies are pretty attractive. Additionally, the large demographic trends in these emerging countries paint a more optimistic picture, once the time horizon gets stretched beyond just one or two years.
Lastly, while the Federal Reserve controls the short-term interest rates, the investment markets ultimately sets the rest of the rates in the U.S., and foreign influence is very large. We do believe that rates will eventually rise and that caution in bonds is warranted. Therefore, we shouldn’t reach for yield by owning a large percentage in long-term or junky credit-quality bonds. While our bond strategy worked against us in 2014, we believe that our view is still warranted for the future. To clarify, our current view does not anticipate rates increasing dramatically, as weakness around the globe, coupled with low inflation, should keep rates relatively low for the short-term.
Investing is a lifelong endeavor that requires patience and emotional fortitude. There will always be uncertainty accompanied by media headlines touting new risks that seem unprecedented. Because of this, we believe that the best approach is to thoughtfully diversify and allocate a portfolio of investments based on fundamental factors, then allow time for market participants to become more rational over time. Furthermore, we feel that regular monitoring of your financial plan, and making necessary adjustments to saving and spending habits along the way, is critical to your long-term success. I am sure that the on-going changes in the markets will remain a challenge in 2015. With that being said, the Bridgeworth Investment Committee and our Advisors will continue to take seriously our role as stewards of your capital.
This commentary is provided for information purposes only and does not pertain to any security product or service and is not an offer or solicitation of an offer to buy or sell any product or service. Any opinions expressed are based on our interpretation of the data available to us at the time of the original publication of the report. These opinions are subject to change at any time without notice. Bridgeworth, LLC does not undertake to advise you of any changes in the views expressed herein. Unless otherwise stated, all information and opinions contained in this publication were obtained from sources believed to be accurate and reliable as of the date published or indicated and may be superseded by subsequent market events or other reasons.
Risks include, but are not limited to, liquidity, credit quality, fluctuating prices and uncertainties of dividends, rates of return, and yield. Past performance does not guarantee future results. Investors should consult their Financial and/or Tax Advisor before making any investment decision.