Thursday, December 5, 2013

UPDATE: The Rest of the Year

by Matt Malick and Ben Atwater

Many clients have been wondering how we see the balance of the year for financial markets.

First, it is important to understand that 2013 has been a tale of two markets – U.S. stocks and everything else.  In contrast to the strength of U.S. equities, nearly every other market, from gold to emerging markets to alternative investments, has seen results ranging from terrible to lackluster.

In 2013, the broadly diversified, or endowment, model of investing dramatically underperformed U.S. markets.  Although we consider ourselves diversified investors, we have been positioned much more in line with what has worked – U.S. stocks.  Therefore, our clients have been particularly successful so far this year.

Although there are no guarantees, the period from Thanksgiving through Christmas has historically been solid for U.S. stocks.  Since 1945, the S&P 500 has averaged a gain of 1.76% with positive returns 71% of the time, according to Bespoke Investment Group.  And, in years where the market is already up 10% leading into Thanksgiving, average returns are a slightly more robust 1.89%.

Bespoke further calculates that in the current bull market, which began in March 2009, the S&P 500 has averaged a gain of 4.41% from the end of Thanksgiving week through year end, with positive returns every year.

The most commonly cited risk to the market right now is the idea that the Federal Reserve could “taper” its quantitative easing program (the purchase of $85 billion per month of Treasury Bonds and mortgage-backed securities in the open market).  Each time the market perceives tapering as a possibility, stocks slide.  We most certainly agree that this is a risk for the market, but we believe tapering is still many months away.

Another potential pitfall for the market is valuation.  Stocks are no longer cheap.  At best, by historical standards, they are now fairly priced at about 16.5 times trailing earnings.  However, in an extended bull market, equities tend to get awfully expensive before valuations correct.  In other words, the stock market usually goes down too much and then up too much.  Unlike Goldilocks, Mr. Market likes it too hot and too cold.

For now, we believe our focus should be twofold:  1) continuing to rebalance accounts to long-term asset allocation targets, which has meant trimming stocks and patiently adding to bonds and 2) looking for stocks that are less expensive than the market, which potentially adds a margin of safety if we encounter a market correction.

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