Fourth Quarter Market Perspective
Global equity portfolios continued to plow ahead in 2013 as the economy showed substantial improvements. Bond markets, real estate and commodities, however, faced headwinds as investors spent 2013 waiting for the US Federal Reserve’s “tapering” to begin. Here is a snapshot of how the indices of several asset classes performed during the quarter and the past twelve months (through December 31, 2013):
|4th Quarter, 2013 Index Performance||Trailing 12 Month Index Performance|
|Source: Morningstar Direct. Past performance is not necessarily indicative of future performance. All investments may lose value over time. These returns do not reflect the deduction of Aspiriant fees nor fund manager fees and may or may not contain the deduction for the reinvestment of dividends and other earnings. Indices are unmanaged and have no fees. An investment may not be made directly in an index.|
The Taper That Almost Wasn’t
The “taper” — a short-hand reference for the gradual reduction of the Federal Reserve’s bond buyback program (quantitative easing) designed to reduce long-term interest rates and support the US economy — kept market-watchers and causal business readers in a “will they or won’t they” holding pattern since June. Finally, in the Fed’s last meeting of the year, the Fed announced a reduction in those bond purchases from the $85 billion per month pace of the last couple of years to $75 billion a month. The Fed, clearly not wanting to change direction too late, started the taper even though the economy has no signs of overheating…the US unemployment rate is still well above target and the inflation rate remains comfortably below the Fed’s 2.0% goal.
Equity and bond markets dropped sharply in mid-2013 upon recognizing that tapering was foreseeable, but equities quickly regained their footing as a slew of positive economic data reinforced the Fed’s message — that the economy’s fundamentals are improving and self-sustaining, leading to less of a need for the Fed’s extraordinary intervention. That said, 2013 was, overall, a relatively placid year for equity markets, and we expect higher volatility during 2014 as the Fed continues the delicate dance of unwinding stimulus in the face of an economy that continues to experience slow, but inconsistent, improvement.
Felt Around the World
In the Euro-zone, the biggest crisis points (Greece, Italy, Spain) have backed away from the brink, and the region as a whole is out of recession. However, growth is anemic and some economists and policy makers have been urging more stimulus and less austerity to boost Europe’s growth. Perhaps these policy makers are eyeing Japan, where economic stimulus policies — coined “Abenomics” after current Prime Minister Shinzo Abe — appear to be having a positive effect on Japan’s economy. Many economists expect to see modest growth in Europe by later this year. While growth in the Euro-zone economy would be a welcome change, we continue to be concerned about the slow pace of fundamental reforms needed to make the EU more competitive and a stronger contributor to global economic growth.
Equities: What Financial Crisis?
The US markets weren’t too concerned about the relatively weak economic numbers from overseas and generated strong returns, reflecting improving conditions in the US economy, stabilizing overseas economies, and continued strong corporate profits. The Wilshire 5000 Total Market Index, the broadest measure of the US market, returned 10.1% for the fourth quarter and 34.0% for the year. This strong performance has prompted some to suggest that US equities are dramatically overvalued; while not inexpensive, we think that US companies’ earnings, low debt and other strong fundamentals justify current values.
Globally, most benchmarks lagged the US markets, although the MSCI EAFE Index returned a strong 22.8% for the year in US dollars. Developing markets, as a whole, generated disappointing performance in 2013 as rising interest rates in the US drew capital out of developing economies and back to the US. Growth, while slower than in the recent past, continues in these markets and, importantly, valuations look compelling relative to most other areas, which could support strong relative performance in the coming few years.
A Challenging Year for Bonds
Fixed income had a rough fourth quarter and an even tougher 2013. With the improving economy and the Fed talking about taking their foot off the gas, interest rates started rising. When interest rates increase, bond prices fall and that was the primary factor driving the negative returns in 2013. Additionally, flows out of bond funds, and especially municipal bond funds, exacerbated the price decreases.
Despite a disappointing year in bonds, we continue to believe that opportunities exist, particularly in municipal bonds, where fundamentals are improving, the risk of default remains very low, and investors continue to earn an attractive, federal tax-free yield. The unfolding recovery continues to look much like the 2003-06 rate increase cycle, when a slowly improving economy meant a slow pace of rate increases; the result then was attractive performance for investors who took a little more risk in their bonds (versus simply holding cash or short-term bonds). (See Aspiriant’s article from March 2013 on this topic.) We expect a similar dynamic to play out over the next several years. That said, we are making some adjustments to clients’ bond implementations soon in response to the evolving interest rate environment.
A recovering housing sector is one of the keys to improved US economic growth, as it supports labor mobility, consumer spending and a range of activity; fortunately, there was an abundance of good news on this front during 2013. As of October 31, the S&P/Case-Shiller Home Price Index, the leading measure of home prices, had a year-over-year gain of 13.6%. With mortgage rates rising, but still near historical lows, the National Association of Realtors is predicting that appreciation in home values will be comparatively modest in 2014.
Unfortunately, the good news in the US housing market didn’t translate into the commercial real estate that underlies the real estate investments in many clients’ portfolios. After several strong years, commercial real estate posted lackluster results as rising interest rates and booming equity markets drew investors into other assets.
Not so Golden for Gold (and Other Commodities)
Diversified commodities, which act as an effective hedge against inflation, particularly in the volatile energy sector, had another tough year, declining a little over 1% in response to continued low inflation expectations. Energy prices were fairly stable in 2013 and this could remain the case for the foreseeable future with the US flush with natural gas, OPEC keeping oil production steady, the possibility of Iran shipping oil in the near future, and Mexico planning to open up its supply to foreign companies. While this is not great news for commodities investors, it is generally very good news for other parts of the economy. And commodities still play an important role in portfolios by countering the risk of inflation and geopolitical conflict.
After a dramatic run since the onset of the financial crisis, gold prices fell precipitously in 2013 as investors looked ahead to the Fed’s tapering decreasing inflation risk. As upward pressure on interest rates continues, gold will likely continue to face headwinds.
The Year Ahead
The economy really seemed to turn the corner in 2013, with significant improvement across a range of measures, and markets reacted accordingly, leading to new highs. While macroeconomic forecasts look promising and we’d all like to think that bad times are behind us, we caution our clients that a Market Snapshot is simply that — an examination of a single, fixed point in time. Many questions remain and we are certain to see more volatility as 2014 unfolds.
Aspiriant is updating our long-range investment return expectations and will roll out updated investment portfolios in the coming months. Your Aspiriant team will continue working with you this year to understand what changes, if any, may be appropriate as you continue to make progress toward achieving your goals.
J.P.Morgan; MSCI Inc.; S&P Dow Jones Indices; FTSE Group; Russell Investments; Federal Reserve Bank of St. Louis; United States Department of Labor; Trading Economics; National Association of Realtors, U.S. Department of Commerce: Bureau of Economic Analysis. Index returns as of December 2013, except where noted.
CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute.
Bureau of Labor Statistics, “Change in Total Nonfarm Payroll Employment” (June 2014).
Important disclosures: Past performance is no guarantee of future performance. All investments can lose value. Indices are unmanaged and you cannot invest directly in an index.
S&P 500 is a market-capitalization weighted index that includes the 500 most widely held companies chosen with respect to market size, liquidity, and industry. The volatility of an index may be materially different than that of a model. You cannot invest directly in an index. Index returns assume the reinvestment of dividends and capital gains. The MSCI ACWI All Cap Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed and emerging markets. It is not possible to invest directly in an index. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 is a subset of the Russell 3000 Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership.
S&P GSCI: The S&P GSCI® is a composite index of commodity sector returns representing an unleveraged, long-only investment in commodity futures that is broadly diversified across the spectrum of commodities. The returns are calculated on a fully collateralized basis with full reinvestment.
Wilshire Global RESI: Is a broad measure of the performance of publicly traded global real estate securities, such as Real Estate Investment Trusts (REITs) and Real Estate Operating Companies (REOCs). The index is capitalization-weighted.