2014 was an extremely challenging year in managing a diversified portfolio. In the end, US equities delivered superior returns compared to most other investment opportunities. Extreme volatility returned to the capital markets during the entire 2nd half of the year, and in particular, during the fourth quarter which included minor corrections in early October and early December followed by strong relief rallies during the months of November and late December. A huge draw down in the global price of oil was the main culprit, responsible for the ensuing market volatility which was further exasperated by weak foreign currencies. An accommodative Federal Reserve also played a role in the appreciation of non-commodity assets.
Equity Market Overview
The 3rd quarter of 2014 trended in monthly directional movements both upward and downward but at the end of the day (quarter) major US indices were little changed from that of the end of the prior quarter. A July selloff followed by a steady August rally and a mixed September left major stock indexes just slightly up from where they were at the end of the June. Year to date, the DJIA is only up 2.81% while the broader S&P has advanced by more than double that mark at 6.70%.
With the 2014 calendar year eclipsing the 1/2 way mark, the world financial markets including most asset classes, have oddly rallied in unison higher. This last occurred in 1993. Accordingly, if you maintain a balanced account which we always advocate at CRA, it most likely advanced in its entirety throughout the quarter, albeit a slow grind upward.
World Stock including Developed International and Emerging Market, the entire bond market, REITS, MLPs, and even commodities all have risen in 2014. The “melt up” reflects market resilience amid uneven US growth, and political and economic unrest in the Ukraine and the Middle East. Much of the market’s broad lift is attributable to sustained and continued efforts of the world’s central banks to a commitment of keeping interest rates low to ensure that their own economies continue their painfully slow recoveries, which in some cases began nearly five years ago.
The first quarter of 2014 introduced us again to volatility, something we did not hear much about during the run in 2013. Stocks and bonds were mostly positive across the board albeit with a modest pull back during the period. The S&P 500 finished the quarter up 1.97% while the Barclays US Aggregate Bond index produced results of 1.84%. Global markets were mixed as seen below.
The Equity Markets
2013 was a very strong year for the US Equity Markets and the outsized returns came as a surprise to even the most seasoned investment pundits. The US broad market had advanced 16.44% during 2012. Going into 2013, market consensus was for a tempered 8% gain, most citing GDP drag as a result of sequestration, government shutdown and tax increases. However the US economy muddled through and the US broad market surprised wildly to the upside delivering final quarter returns of over 10%.
The DJIA which has advanced for its fifth straight year had its biggest yearly gain since 1995 and returned 26.50% and the S&P 500 advanced 29.57% logging its best year since 1997. Not to be outdone, the Russell 2000 returned 37.03% in 2013, its biggest rally since 2003. Sector leaders included consumer discretionary and health care.
The 3rd quarter market chatter primarily revolved around the anticipation of the Federal Reserve’s resolve to finally begin to reduce its bond buying, which commenced a year ago as part of QE3. The conventional wisdom was that there was going to be a slight pull back of the targeted bond buying or “Taper” meaning a reduction by 10% or so of the monthly $85 billion bond buying program. The Fed ultimately surprised the markets at the conclusion of the two day meeting on Sept 18th with no tapering announcement at this time. In its statement, the FED said that, “tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market.” So the Fed decided to wait for “more evidence that progress will be sustained before adjusting the pace of its purchases”. Was this meant to be code for, “Mortgage rates jumped too much and we are worried about stopping an already slow recovery”?
Markets at first rejoiced and then promptly sold the following day, now turning its attention to Washington gridlock related to the debt ceiling and now government shut down. The DJIA closed down 7 of the final 8 trading days to end the quarter.
The big news event of the second quarter revolved around the sudden rise in US interest rates based upon the possible conclusion of the FOMC’s latest stimulus program. Consequently, the US stock market posted its first monthly decline since October 2012 as the second quarter came to a close. The DJIA declined by 659 points alone in a 4 day trading period between June 19th and June 24th. In addition, gold, precious metals, REIT’S, developed international and emerging markets all traded lower based upon that assumption as well as the prospect of a China slowdown, including its own looming credit crisis. Consequently, during the latter half of the second quarter volatility returned to the capital markets in full force.