2014 Lookback: U.S. Strength Prevails

One of the most popular American comedies in recent years involves three friends who wake up from a bachelor party in Las Vegas with a tiger in their room, their bachelor missing and no memory of the previous night. It is not until the credits roll that viewers are witness to an array of selfie-like snapshots that reveal what actually happened during the course of the movie.

Our market experience of 2014 was not unlike the clever plot device.  Market “selfies” or snapshots of 2014 reflect a few feel good moments (employment on the rise), shocking twists (the decline in U.S. Treasury yields), drama (the stock market sell-off in October), endurance (the November market reversal after the sell-off) and a shocking end (the dizzying drop in oil prices).  
However, despite the roller coaster ride of events in 2014, the year’s “plot summary” will show a year that generated positive market returns for a majority of the major asset categories.  At the top end of general asset classes,  the S&P 500 stock index returned +13.7%, and bonds, as measured by the Barclay’s Capital Aggregate Index, earned a strong and universally unexpected return of +6.0%.
Below is a look at the economic and market “selfies” for 2014, providing a backdrop for 2015:
Economic/Geopolitical Developments:

  • Despite a rough first quarter with disruptive winter weather, the -2.1% economic growth did not put a damper on the year’s estimated overall growth of +3.0% -- a rate equal to the historical long term average and a good signal of economic recovery.
  • Unemployment showed positive gains and trend throughout the year, ending at an estimated +5.6%.
  • The Federal Reserve’s bond buying program which served to restore stability to the U.S. economy was trimmed throughout 2014 and ceased by year's end.  Investors seem at ease with the removal of this monetary stimulus.
  • The Federal Reserve repeatedly indicated they will not rush to raise interest rates.  With overseas rates so low, there is demand for U.S. debt, also supporting lower U.S. interest rates.  Likewise, high international demand for U.S. debt (given low interest rates levels in Europe and Japan) will help keep our rates low. 
  • For now, the expanded threats of terrorism have generally been shaken off by the markets, as have the skirmishes with Ukraine and Russia and Crimea’s secession from Ukraine. 
Market Developments:

  • Surprisingly, there was a further drop in long term interest rates.   10-Year Treasury rates decreased to 2.17%, providing a 10.7% annualized return, and the 30-Year Treasury rates decreased to 2.75% -- again inducing investors to take on more risk. 
  • The first two weeks of October caused minor havoc in markets. The S&P 500 experienced a 5% decline.
  • The last two weeks of October and the month of November accounted for a significant portion of 2014 returns in most asset categories (i.e. 40% of S&P).  
  • Crude oil prices dropped by 50%, to five-year lows.  While good for U.S. consumers, it does not bode well for oil producing nations in the Middle East, Russia, and Venezuela.   The reduction in prices is likely to have employment repercussions.    
Maintaining Perspective

When large capitalization U.S. stocks lead other asset categories, diversified investors can feel left behind with seemingly sluggish returns, a feeling heightened by a home country bias.  However, the very essence of diversification means that all but one category does not lead.  The “hot” asset category is always subject to change. 
U.S. Large Cap stocks have recently served investors well, and before that, Small Cap and Emerging Markets asset classes were outperformers.  In fact, Emerging Market equities is the best performing asset class for the past 10 years, yet, true to the nature of diversification, is one of the past year’s worst performers.
Behavioral economics tells us that investors, in general, are subject to a state of “recency bias” where they place undue weight on recent investment performance.  This results in the impulse to chase markets and fall into a buy high/sell low cycle.   In the current environment this might lead to overconcentration in the leading asset class – S&P 500 stocks.  
However, experience informs us that no asset class can consistently outperform. Ultimately, diversified portfolios with reasonable asset allocations create greater potential for better long term returns and protect investors from unproductive biases.
In Summary

The U.S. bull market is nearly six years old, returning double digit gains in five of the last six years.   Low interest rates, strong corporate earnings and strength in the U.S. economy suggest that there is still room for positive stock market returns going forward.    
We look ahead to 2015, and consider various risks and opportunities, not knowing the nature of next year’s market selfies.  While many of the same themes will likely exist, it is important to maintain our commitment to a disciplined investment program that considers investment opportunities suitable for our clients’ long term goals while providing them the ability to cushion the inevitable bumps in the road.    
As always, we are open to conversations with you about the markets, your portfolio and the ways we can help you accelerate towards your financial goals.  I encourage you to let us know if you have any questions or concerns.

David H. McKinley
President and Managing Director
Chair, Investment Services Council (ISC)

Brian R. Lipton
Director, DC Metro Region
Member, ISC Strategy Committee