2013 Review and Look Ahead to 2014-Happy New Year!

—January 7, 2014

The Markets:

Risk assets in the U.S. such as stocks and high yield “junk” bonds were the place to be for investors in 2013.  The major U.S. stock indices rose across the board producing double digit gains for the calendar year.  Traditionally “conservative” assets, such as U.S. Treasury bonds or high grade bonds in general, underperformed due to rising interest rates through the second half of the year.  A brighter outlook for the economy and talk since mid-May that the Fed was poised to start reducing bond purchases lifted Treasury yields and weighed on bond prices.  Commodity prices also fell in 2013.  Gold and silver prices dropped during the calendar year after talk of a Fed “tapering” of its current bond buying program.

A Super-Easy Monetary Policy:

In order to stoke economic activity and hiring, the Federal Reserve has been holding the fed funds rate at near zero since late 2008 and has embarked on a series of long-term bond purchases, popularly called quantitative easing or QE for short.

Two goals—

  • Keep interest rates low in the hopes that spending and borrowing by consumers and businesses spark economic activity and hiring.
  • Boost asset prices, such as stocks and housing, hoping the so-called “wealth effect” will encourage spending. In theory, an improving net worth may aid consumer confidence and lift spending.

Undoubtedly, QE has been controversial and it has its detractors. Still, most agree the bond buys have boosted stock prices – see Figure 1, though some would argue it has been an artificial lift.


Fed policy has not been without costs. Low rates have punished savers that rely on safe investments for income, encouraging some to climb the ladder of risk. Some of this additional risk-taking, what some call “engineered risk,” has led investors to the doorstep of equities/stocks.

We’ve experienced a subpar economic recovery, but that hasn’t prevented companies from posting record profits, on near record profit margins (S&P Dow Jones Indices). Reason – a gradual improvement in the economy has led to very modest improvements in sales along with a major focus on cost-cutting.  The problem?  Companies can only cut costs so much before it will take a continued improvement in sales and net revenues to fuel earnings.  If that doesn’t occur, the direction for stock prices in general would most likely be lower.

Stock Buybacks/Dividends:

Given record profits and few opportunities to expand and re-invest, corporations have returned an enormous amount of cash to shareholders via stock repurchases and dividends.  While the repurchase of company stock has underpinned the market, dividends have also sweetened the pot. S&P Dow Jones Indices estimates that companies returned a record $310 billion last year in the form of dividends.

Our Portfolios:

Performance for our portfolios in 2013 disappointed at all risk levels due to our underexposure to equities/stocks after the first quarter.  We remained very diversified all year, but the positions we held in fixed income/bonds and “alternative” assets, which included exposure to gold, silver, and commodities in general, hampered our returns for the last three quarters of the year.  During the second quarter, specifically from mid-May through the first week of July, interest rates spiked (bond prices fell) and commodity prices dropped sharply on fears of an early Fed “taper” of their quantitative easing program of bond buying.

We still hold the longer term opinion that stock prices have gotten too high and are presently overvalued. We have discussed our views throughout 2013 of what could lie ahead, and now that 2014 is here, we expect to see the longer term market cycle resume.  We still think interest rates could move lower this year from their present levels (bond prices would move higher), and commodity prices rise.  The current rate for 30 year fixed rate mortgages now stands at 4.53% and 3.53% for a 15 year fixed rate mortgage.  (Bankrate.com)   We also feel a stock market correction of some type is well overdue, and just since the first of the New Year, stock prices have shown continued signs of possibly being in a topping process.  We were early in our reduction in stock/equity positions during 2013, but time will tell as to the ultimate results for our strategies as we move into 2014.  We will continue to monitor this on a regular basis and keep you posted.

Looking Forward to 2014 and the Road Ahead:

The global economy has yet to shake off the shackles of the 2008 financial crisis that threw the U.S. economy into a tailspin.  The International Monetary Fund expects global Gross Domestic Product to run at 3.6% in 2014, up from an expected 2.9% this year. But that’s below the rate of 5% from 2005 – 2007 (Bloomberg News).

The U.S. economy did show signs of perking up at the top of 2011, 2012 and 2013; yet, it failed to break free of the low growth orbit it has been stuck in since the recovery officially began in the second half of 2009 (NBER).  Are we in another temporary upswing before we settle back down?  A two-year budget deal just approved by Congress provides some degree of certainty coming out of Washington, and the easing in the sequester (automatic spending cuts) translates into a little less of a fiscal drag in 2014.

But lest we get carried away, about $44 billion in additional 2014 spending (between defense and domestic programs – Source: scribd.com) is barely a ripple, as the total value of the U.S. economy stands at $16.9 trillion (BEA).  The debt ceiling debate is also coming up and could once again create uncertainty as well as questions surrounding the U.S. credit ratings.  The next deadline for the debt ceiling is currently February 7th.

Fed Watch

At its December meeting, the Federal Reserve announced a $10 billion reduction in monthly bond purchases. At $75 billion each month, monetary policy remains unusually accommodative. Following the expected conclusion of the latest round of bond purchases, Fed Chief Ben Bernanke has pledged to keep the fed funds rate at near zero for a considerable period.  Bernanke also made it clear at his December press conference (Fed transcript) that Janet Yellen, who takes the helm of the Fed early this year, supports the current monetary roadmap.

How the Fed plans to unwind its bloated balance sheet will come into view as QE ends per current central bank plans. Many analysts have fretted that excess liquidity could eventually spark unwanted inflation.


Potential Clouds Overhead in 2014:

The skies never really clear and market corrections rarely follow the script laid out by the consensus. The list below is not exhaustive but represents some of the potential problems the U.S. and global economies could face.

1-      The two-year budget deal does not eliminate the possibility of another down-to-the wire debate on the debt ceiling. Recall the agreement that ended the October government shutdown extended the government’s ability to borrow until early February, but the Congressional Budget Office estimates the use of extraordinary measures could extend the deadline until early March.  Whenever the clock strikes 12, another bruising debate, if it were to occur, could unsettle markets.

2-      Europe appears poised for a very slow economic recovery. Banking woes have subsided but structural reforms are still needed. There’s always the possibility that smoldering embers could reignite.

3-      Healthcare reform and uncertainty of its overall impact on individuals and businesses should start to unfold during the year.

4-      China is attempting to transition from investment-led boom to a more balanced, consumer-led economy. But debt levels are up and some worry about overcapacity (Barron’s).

5-      Just how the Fed can unwind its swollen balance sheet is still a big unknown and just what the actual results will be to the economy, inflation, and the U.S. dollar.

We appreciate the privilege of serving all of you and truly hope you had a very blessed Holiday Season.  We look forward to a great 2014 together and to seeing or talking with most of you in the coming weeks to provide you with your year-end review and share our detailed outlook for 2014.Out

God Bless,

Your TEAM at F.I.G. Financial Advisory Services, Inc.


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1 The Dow Jones Industrials Average is an unmanaged index of 30 major companies which cannot be invested into directly.  Past performance does not guarantee future results.

2 The NASDAQ Composite is an unmanaged index of companies which cannot be invested into directly.  Past performance does not guarantee future results.

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