Investment Commentary – February 2014

They Say What Goes Up Must Come Down, but not When

Last year we told you about some market indicators, Market Indicators and the Outlook for 2013, that have pretty impressive long-term success rates, including the SuperBowl indicator. The best thing about SuperBowl XLVIII, for anyone other than Seahawks fans, was that the NFC team won, which is supposed to signal a good year for equity markets. However, there is a competing line of thinking that after a big run up in the US last year we should expect weakness in 2014.

First of all, weaker isn’t necessarily weak…especially following a 30% advance (S&P 500 price return in USD). Everyone shouting from the rooftops that a gain of this magnitude in 2013 means we are headed for the red in 2014 should pay attention because rate of change is a terrible measure of potential extreme conditions. More often than not, strong positive momentum markets are followed by weak positive momentum markets…not falling markets. When we look at negative momentum markets, the results are different; bull markets carry momentum while bear markets finish with exhaustion.

Since 1945, the S&P 500 has gained more than 20% in a calendar year a total of 21 times and these are widely recognized as some of the best years for stocks. Clearly, there is plenty of historical evidence to support all of these talking heads sounding the warning bell for equities in 2014, right? Not quite…in fact, stocks rose 10%, on average, in the year following a 20% or more gain, during the post-1945 period.

But, you have to remember that this is a pattern and not a rule. There are no guarantees, plus exceptions can and will occur. The data shows that the boom-bust pattern has held at various times, with the worst post-boom year returns ranging from losses between 6% and nearly 20%.

There is adequate support for the idea that markets will pause and likely correct 10% or so in the first half of 2014, due to more debt ceiling concerns and QE tapering. Yet, there is still ample liquidity in the markets to suggest that it is not likely to cause an earnings recession. Some are definitely becoming concerned with mounting P/E ratios, but we do expect central banks to remain extremely accommodative for a few more years.

In addition, some investors have presumably been taking profits and we could see some additional such activity as investors seem spooked by the recent spate of down days, some of which have been quite sharp. In fact, just last week when the S&P 500 was at its lowest level year-to-date, the index was only 5% off its all-time high, reached January 15th of this year. This is by no means a significant correction and things seem to have stabilized somewhat in the interim.

As we stated before, these types of patterns are certainly of interest, but they play no part in how your T.E. Wealth portfolio is actually managed. Instead, we consider your goals, objectives, risk tolerance and investment time horizon in order to put together an appropriate investment plan for you.

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