The New Year brings both opportunities and challenges. If January is any indication, the challenges may be greater this year versus last year. Rising to the investment challenge takes commitment and patience. One of the best ways to calm emotions and stay committed is to set realistic portfolio return expectations. Last year was a fabulous year for U.S. stocks, one of the best. It was a different story for gold, emerging markets and long-term bonds. Our advice is to begin this year expecting less from U.S. stocks and a little more from bonds and commodities. Before the market throws cold water on your financial fantasies, please bring your return expectations back down to earth.
The bull market in U.S. stocks is nearly five years old and last year was the best individual year for stocks since the 2008 collapse. This is the way the stock market travels through time; on average, two years up for every one year down. We are not saying 2014 will be a down year for stocks; rather we think it will be a transition year back to normalized equity returns. Our fundamental evaluation of the stock market based on earnings estimates, price earnings ratios, consumer confidence, and GDP growth tells us to expect stock market returns in the five to ten percent annualized range over the coming years. It is important to focus on the horizon, not the daily fluctuations, to successfully reach your financial destination.
Entering 2013 the bond market was set up for a down year. The Federal Reserve exhausted its monetary tool kit to guide interest rates to generational lows and the U.S. economy was on the mend. In May 2013, the Federal Reserve discussed ending future tapering at some point and the bond market immediately sold off. The bond market reaction to the comments turned out to be much worse than the event itself. The Fed just announced a second ten billion round of tapering and the bond market is performing quite well.
In January, equity markets around the global got off to a rocky start as the Federal Reserve initiated their tapering program and weak manufacturing results from China threw a scare into the global equity markets. The S&P 500 lost 3.56 percent in January. The Barclays Aggregated Bond Index, which benefitted from a mini flight to quality trade, gained 1.48 percent for the month. Commodities rebounded after a difficult period with the Dow Jones UBS Commodity Index gaining 0.30 percent. International stocks lost 1.54 percent for the month. Emerging market stocks, led by currency concerns and China, created another difficult month for this sector. The MSCI Emerging Market Index lost 6.49 percent of its value.
We believe 2014 will be a good year for investors. It will be a less stressful year for those investors who establish realistic return expectations. Expect the stock market to delivery high single digit returns and the bond market to produce low single digit returns. At the end of the year these expectations will either; fall short, meet, or exceed. Regardless of the final outcome, setting realistic return expectations will curb the disappointment or suppress the euphoria and keep you focused on your long-term financial horizon.
