What Kind of Year Has It Been?
The year may have gotten off to a rocky start, but the US markets finished the year strong. US stocks pushed to record highs again and again throughout the year and US bonds recovered from their 2013 losses to post significant gains. Unfortunately, the picture was not so cheerful in foreign markets. As we look at the yearend numbers, it is helpful to review the events that shaped the markets in the past 12 months.
Investors entered 2014 with high expectations. The previous year was a fantastic year for the stock market and there were signs that the US economy was finally seeing its long-awaited recovery. Unfortunately, an unusually brutal winter meant that those hopes would go unrealized for months. The so-called “Polar Vortex” slowed shipments, froze consumers, and left investors eager for the arrival of summer.
Meanwhile, foreign markets were struggling with more fundamental issues as emerging markets stumbled. The trouble seemed to start in China, which struggled with a debt crisis that seemed to get worse with each passing month. Around the world, companies were hurt as Chinese corporations scaled back their appetites and attempted to navigate the crisis. In particular, the nearby emerging markets, which trade primarily in natural resources, were stung by the sudden decrease in Chinese demand.
By Summer, the global economy seemed to find more solid footing. The US economy emerged from the winter and its stock market started to hit record highs on a monthly basis. China also weathered the worst of its debt crisis and foreign markets seemed eager to get back down to business, in spite of growing conflicts in Ukraine and Israel.
The fourth quarter saw some larger issues come to the forefront. The US Federal Reserve got the ball rolling when it announced the end of its asset buying program, known as quantitative easing. This program involved buying bonds and mortgage-backed assets on a large scale in the attempt to encourage lending. More pessimistic analysts predicted that its end would be a shock to the global economy and result in a market correction, but the markets had been anticipating its end for months and hardly reacted.
On the other hand, investors were definitely surprised when the Japanese Central Bank announced that it would be ramping up its own stimulus program. At first, investors seemed pleased by this commitment, but they seemed to change their minds when Japanese inflation failed to respond to these new measures.
Finally, the price of oil became an international issue. While it had been in steady decline since early summer, it crossed an important price threshold in November and investors finally took notice. Reactions were mixed. Those countries that import most of their oil benefit from the cheaper price, while those countries that export oil were struggling to replace that lost revenue. In the US, a slight decline in the prices of oil is an advantage for consumers, who are now free to use those savings to purchase other goods, but a large drop will cause significant harm to our shale oil industry and the energy sector as a whole. We talked about this in greater depth in last month’s Market Review, and this will continue to be an issue in 2015.
December was a surprisingly difficult month, not just for stocks but for bonds, commodities, and foreign investments as well. We would usually expect to see a boost from the Christmas season and from investors attempting to close out the year on a positive note, but this was not the case. For the year, US stocks and bonds outperformed their foreign counterparts. Global stocks finished the year with low, but positive single digit growth and our higher-risk portfolios kept pace. Global Bonds on the other hand finished the year flat and left conservative investors disappointed. Our conservative portfolios showed significant outperformance resulting in positive returns for our investors. Overall, our strategies offer controlled and broad-based diversification with the goal of providing returns that are worth the risk. Looking to 2015, we will introduce several allocation changes as we attempt to navigate market risks and capture the resulting opportunities.
- US Large Cap Stocks (IVV) were down for the month of December but our US Stock allocation performed positively due to our use of US Mid Caps (VO) and US Small Caps (VB). Over the course of 2014, our elevated US Stock exposure helped provide strong returns across our portfolios.
- Foreign stocks (VEA, VSS, VWO) saw another significant decline during the final months of 2014, surrendering all of the gains that they made during the remainder of the year. Our decision to lighten Emerging Market Stock (VWO) exposure a year ago was rewarded during 2014.
- December was rough for US Bonds, but they finished the year in the black and provided stability during some of the rocky months of 2014. Although US Bank Loans (BKLN) and US High Yields (JNK) were barely ahead for the year, our use of US Corporates (LQD) and Mortgage-Backed Securities (MBB) contributed to the returns across our portfolios.
- Foreign Bonds pulled back in December and finished the year in red. Emerging Market Debt (PCY) was the only bright spot for the year and benefited our strategies. Despite their difficult year, foreign bonds still provide a valuable hedge against declining stock prices.
- The declining prices of oil continue to weigh heavily on Hard Assets, specifically our diversified commodity position (DBC) and master limited partnerships (AMJ). However, Global Real Estate (RWO) offered some refuge and was the best performing portfolio component in 2014.
- Hybrids were flat in December, but they were the stars of 2014. In a year of cautious optimism and mixed expectations, hybrids were a smart play providing some of the most attractive returns across stocks and bonds. We increased this exposure for 2014 which boosted our portfolio model returns.
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