Newsletter | January 2014

January 13, 2014 -  DJIA = 16,437 - S&P 500 = 1,842 - Nasdaq = 4,174 

"I Took Off For a Weekend Last Month Just To Try To Recall The Whole Year."[i]



[i] J. Buffett, 1977

 


During the New Year's celebrations, likely there were more than a few toasts to Ben Bernanke.  Of course, alcohol is a normal part of holiday gatherings, so it's understandable that common sense and logic may have impaired partiers to the point that our Fed Chairman was credited for the stock market's success.  While central bank policy has a big influence (perhaps too big) on the capital markets, we're not sure how much of the equity sector's move should be attributed to it.  That issue aside, 2013 was undoubtedly a very good year for stocks.  While the question of whether last year's historic performance was a coincidence or a direct result of monetary policy needs to be examined closer, let's take a look back at last year.  . 

 

One of many notable market developments during 2013 was the fact that stock indexes were never down on the year.  From the January 2nd spike, at no time was the S&P 500 negative year-to-date.  Secondly, there were only two down months - June and August.  For those inquiring minds, there have been two years with 11 out of 12 advancing months - 2006 and 1958.   

 

2013 was the best year for the Dow Jones Industrial Average since 1995.  During the year the blue chip index closed at record highs 52 times.  It was the 5th consecutive yearly gain and the index ended 2013 on a 4-month winning streak.  Among companies within the index, Boeing was the best performer (up 81%) while IBM was the only loser (down 2%). 

 

The S&P 500 had its best year since 1997.  The two best performers were Netflix (up almost 300%) and Best Buy (up 237%) while Newmont Mining was the worst stock in the index (down a little more than 50%).  2013 was the 10th best year ever for the S&P 500 while the Nasdaq's 38.3% rise ranked as the 7th best.  Here are last year's returns for the major averages.

 2013[i]

 

Dow Jones Industrial Average    +26.5%
S&P 500                                      +29.6%          
Nasdaq Composite                      +38.3%

Russell 2000                                +37.0%

                                

I

Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends

 

 

Assisted by 20/20 hindsight, 2013 was pretty easy.  Stocks were stronger from the beginning of the year and, except for a couple of brief declines, steadily climbed throughout the year.  By December, everything seemed straightforward and simple. Living it in real time, however, was a much different story. 

 

"All of The Faces and All of The Places,
Wonderin' Where They All Disappeared."[ii]

Naturally, 2013's story starts as "Auld Lang Syne" was being sung to ring out 2012. In sharp contrast to current sentiment, at that time there was widespread pessimism overhanging the markets.  Everyone was convinced that stocks were too risky and that bonds (which were finishing a very good year) offered the best combination of safety and return.  Throughout 2012, investors had been bombarded with a series of developments that would surely shake the stock market at any minute - Greece, Obama's reelection, an elevated unemployment rate, sub-normal economic growth, record deficits, and as if to put an exclamation mark on the year, the fiscal cliff.

 

As 2013 began and the widespread anxiety over the "fiscal cliff" subsided, everyone started to realize that the world wasn't going to end.  But stocks had already spiked so it was logical to wait for the correction which had to be just around the corner. Unfortunately for those not invested, it never arrived. But next was the sequestration that would surely knock the legs out from underneath the economy and the market.  Once again the talking heads proved to be wrong. 

 

After this was Chairman Bernanke's comment that the Fed might begin to "taper" its monthly bond buying which caused second thoughts about rising stock prices (this did cause a bloodbath in the bond market).  And while we survived these challenges and even managed to name the new royal baby, the government shut down was sure to be end of the world.  As we all know, this too came and passed.  Perhaps one of the lessons learned from 2013 is that following conventional wisdom can be risky. 

 

While some have been emotionally converted just by higher prices, others ponder the mystery of how record levels coexist with bad headlines.  To this latter group the current landscape is a bubble that will ultimately burst.  And while the "bubble" debate is ongoing, the explanation behind the stock market's incredible rally involves dynamic features. 

 

To be sure the bears and bubble supporters have ammunition.  News flows seems to be constantly negative, the public is ready to tar and feather everyone in Washington, job growth is anemic, and we face numerous geopolitical problems.  However, there are many reasons for optimism.  These include the drive toward energy independence in the U.S., "onshoring" or the return of manufacturing to the U.S. (assisted by lower energy costs and robotics), the increasing global "digitization" led by U.S. companies, medical and biotech breakthroughs, and continued growth of emerging market's middle class. 

 

Undoubtedly, low interest rates have helped provide capital to these developments.  However, let's hope that these projects are economically viable beyond suppressed interest rates.  Otherwise those calling this a bubble will be right. 

 

"If it Suddenly Ended Tomorrow, I Could Somehow Adjust to The Fall"[iii]

 

This returns us to the New Year's partiers' raising a glass to Ben Bernanke which leads to a question - have the Fed policies worked and, if so, how much of the economy and stock market's performance should be attributed to monetary stimulus?  Undoubtedly, they have done a very good job of printing money and buying bonds.  Additionally they have successfully kept the short end of the yield curve low.  Of course, some think the Fed policy has been successful just because banks aren't failing and the stock market is setting records.  By those standards alone, they have done a good job. 

 

To others, ZIRP, QE, Operation Twist and the other various programs are viewed with more skepticism.  Andrew Huszar, who had spent seven years at the Fed before working on Wall Street, returned to the Fed to manage one of the QE operations.  Specifically, he managed the Fed's $1.25 trillion mortgage buy back program during 2009-2010.  In a The Wall Street Journal Op-ed, he criticizes the policy by saying, "The central bank continues to spin QE as a tool for helping Main Street. But I've come to recognize the program for what it really is: the greatest backdoor Wall Street bailout of all time."[iv]

 

 

Beyond the debate of its effectiveness, the Fed's stimulus policy has added another layer of risk to the capital markets.  The various programs, our central bank has admitted, have never been tried before and, consequently, their outcomes are uncertain.  The Fed has also stated on multiple occasions that they are 'data dependent' or that they rely on economic information to judge whether more or less stimulus is needed.  Yet, many economic reports are far from accurate when released.  For example, the monthly employment report, one of the most widely followed reports, is subject to huge revisions.  Further these revisions continue many months after the initial release.  For a data dependent analyst, we would think that this decision process is, at best, cloudy. 

 

Whatever the driver, the stock markets' 2013 performance was welcome.  Due to many factors, however, we'd caution against expecting a repeat.  Valuations are no longer as cheap as they were a year ago, economic growth is not certain, and sentiment seems a little excessive.  On this last point, the bull/bear ratio has been extremely bullish for weeks (this is a contrary indicator).  Furthermore, The New York Times columnist James Stewart recently wrote, "In the many years I've been surveying experts for their predictions for the coming year, I cannot recall another time when optimism about the stock market, the economy and corporate profits was so widespread.  As is pessimism about the bond market."[v]

 

While we are reluctant to make specific predictions, we are confident there will be some curve balls thrown at the markets some time during 2014.  As usual, these situations will provide opportunities.  The hard part will be to separate the short term noise from any meaningful change in the economy or market's composition.  We look forward to the journey and hope to raise a toast to 2015. 

 




This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The NASDAQ Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System. The Standard & Poor's 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. The Russell 2000 Index is an unmanaged market-capitalization weighted index measuring the performance of the 2,000 smallest U.S. companies, on a market capitalization basis, in the Russell 3000 index. It is not possible to invest directly in an index. Investing involves risks, including the risk of principal loss. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability and differences in accounting standards. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. If assistance is needed, the reader is advised to engage the services of a competent professional.

Past performance does not guarantee future results

 

Jeffrey J. Kerr is a registered representative of
LaSalle St. Securities, LLC, a registered broker/dealer.
Kerr Financial Group is not affiliated with
LaSalle St. Securities, LLC. Securities are offered
Only through LaSalle St. Securities, LLC
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