With plenty of wind in their sails, bulls coasted comfortably into year-end to close out 2013 with a stellar performance, as Santa made his widely-expected appearance on Wall Street. In fact, stocks saw one of their best years ever and the strongest since 1997, with the S&P 500 boasting a total return around 30% while closing the year right at its all-time high. It is notable that more than 450 of the 500 stocks had positive returns, and about half of the gains for the year occurred after Labor Day. Also, for the last two months, bulls showed a noticeable preference for higher-beta, lower quality names (“risk-onâ€).
Other asset classes faired much worse. The Barclays U.S. Aggregate Bond Index fell -3%, which was its first down year since 1999. Gold lost -28%, which was its worst year since 1981. Absent a constant threat of global economic meltdown, it seems that nobody anymore feels much need to keep stores of gold in their portfolio.
An analysis of S&P 500 sector performance for 2013 shows that Consumer Discretionary, Healthcare, Industrial, and Financial led the way, with each up by more than 30%. In retrospect, it was no surprise that some of the more economically-sensitive sectors led during an economic recovery and surging stock market. Not far behind were Technology, Materials, Consumer Staples, and Energy, which were each up north of 20%. At the bottom were defensive sectors Utilities and Telecom, which were up less than 10%.
If I look back at our SectorCast ETF rankings in January 2013, the top ranked sectors during the month included Healthcare, Technology, Industrial, Consumer Staples, and Financial, while Telecom and Utilities were ranked at the bottom. So, overall, it looks like it was pretty accurate, particularly when you consider the consistently high sector correlations all year. However, Consumer Discretionary also was ranked near the bottom, primarily on valuation even though it displayed one of the highest projected long-term growth rates, so the model definitely missed foreseeing the superb performance of this sector.
Of course, the strong market was driven largely by the Federal Reserve’s monetary stimulus program, which kept interest rates so low that capital had virtually nowhere to go but risk assets, particularly equities. However, liquidity couldn’t do it alone, and encouraging signs of U.S. and global economic recovery have supported the bull case, as has continued slow but steady corporate earnings growth.
Bears would argue that the Fed has merely created a stock market valuation bubble, as the extreme levels of liquidity have failed to trickle down throughout the economy in the form of lending, but instead have been used by banks’ trading departments, and the big corporations have chosen to use cash and cheap debt to buy back their shares rather than invest in PP&E and new hiring.
Indeed, P/E multiple expansion has been an undeniable contributor to the market’s stellar performance, as the S&P 500 average P/E has grown from the mid-13’s to the mid-16’s, versus a historical average of mid-14’s. True, the low interest-rate environment justifies higher multiples in equities, so current multiples are not yet unreasonable. But further market gains will need to come from robust corporate earnings growth — and that will require top-line revenue growth rather than cost-cutting, productivity gains, and efficiencies that is pretty much exhausted at this point.
For 2014, cash will continue to offer no return for the foreseeable future (i.e., “cash is trashâ€). Longer-term (10-20-year) Treasuries will be at risk of loss of principal as long-term rates creep higher, while mid-maturity (2-5-year) bonds will offer a small return without a significant risk to principal. However, Scott Minerd, Global CIO of Guggenheim Investments predicts the 10-year Treasury yield will remain range-bound with a peak at current levels around 3%, while the fed funds rate should stay near zero, perhaps until 2016.
