In Like a Lamb, Out Like a Lion

- 2014 1st Quarter


2014 began with a whimper, and a tremendous sell-off that saw the market drop by slightly more than 7%, but gave way to a 'lioness' recovery that offset most previous losses. After a tremendous 2013, stocks got off to a slower start in 2014. Mixed economic data, harsh winter weather, growing tensions in Ukraine, and China’s slowdown contributed to some ups and downs in the financial markets. Nevertheless, the S&P 500 Index gained 1.8% for the quarter, its fifth consecutive positive quarter and its longest positive run since 2007. The defensive utility and healthcare sectors led the way. Last year’s best performing sector, consumer discretionary, was the worst performer for the quarter. Value stocks outperformed growth stocks and mid cap stocks outperformed both large and small cap stocks.

While the expectations for 2014 have been optimistic and positive, they are also cautious in comparison to last year. The year started off a bit rocky due to significant concerns about Emerging Markets which fell by more than 10% in January. Then, in February, Janet Yellen was sworn in as the Chair of Federal Reserve and the Market fell sharply due to her luke warm and less-than reassuring comments about the Fed’s downsizing of the Quantitative Easement program from a mid-January Press Conference. On March 19th, Yellen held her first official Press Conference and gave several reassuring comments that contributed to the recovery of the market.1

The Market

With the Market hitting all time high levels in 2013 and continuing to gain in 2014, everyone wonders whether the `Market Party’ is almost over. Since 2009, consumers and investors have been feeling pretty confident while the high stock valuations have some fearing that a bubble in stock market valuation is again developing as investors become overly optimistic.

To assess whether a `bubble’ has developed compare the price-to-earnings ratios (PEs) of all 62 of the industries of the S&P 500 Index today to the same day 14 years ago in 2000, at the top of the bull market — the last time a bubble in stock market valuation popped. The stock market was really “bubbly” in April 2000, with valuations of many industries floating higher, but now industry valuations are relatively flat.2

In April, 2000, 16 of the 62 industries which accounted for 70% of the total market value had a P/E Ratio of over 30. Today, only 4 industries of the 62, accounting for less than 4% of the total market value, have P/E Ratios over 30. This can signify that while the run in the stock market is not just beginning, it is also not close to being over.3

More specifically, the First Quarter Market found Value generally outpacing Growth, with mid-cap stocks topping both large- and small-cap stocks. In this environment, the Russell Midcap® Value Index did very well, gaining 5.22%, while the Russell Midcap Growth Index gained 2.04%. In the large-cap arena, the Russell 1000® Value Index grew by 3.02% mark with only 1.12% growth for the Russell 1000 Growth Index. Investors were risk-aversed in the 1st Q, 2014 which saw small-cap stocks lag: the Russell 2000 Value Index posted a 1.78% gain and Russell 2000 Growth Index was up 0.48%.

In the bond market, concern early in the quarter about slowing U.S. economic growth helped drive yields lower on U.S. Treasury securities. The lower yields were good news for bond prices: Barclays U.S. Aggregate Bond Index, which holds Treasuries and other investment-grade debt securities, gained 1.84% for the quarter while Barclays U.S. 1-3 Year Government Bond Index ended up 0.14% & the 13-week Treasury Bills returned 0.01%. High-yield bonds were one of the bond market’s better performers, with the Barclays U.S. Corporate High-Yield Bond Index rising 2.98%.

Performance of various market sectors illustrates how the more aggressive and defensive parts of the market respond to the economic climate. 2013‘s bull market saw the consumer discretionary sector post an impressive price-only return of roughly 41%. Economists measure risk-aversion by looking at the ratio of consumer discretionary stocks to those in the consumer staples sector. In good times discretionary stocks have typically outpaced staples, and vice versa when the economic climate deteriorates.

During the 1Q, 2014, as shown in the bar chart, consumer discretionary went from first to worst, losing 3.16%, which was considerably weaker than telecommunication services, the second-worst sector. At the same time, utilities and health care, both known as defensive sectors, vaulted into the lead with solid gains. If the bull market in stocks continues, we would expect more-cyclical sectors such as consumer discretionary, information technology, and industrials to resume a leadership role relatively soon.4

The World

Another factor that kept investors on the edge of their seats was the unfolding drama in Ukraine and Russia. This became a world issue when then Ukraine President Yanukovych stopped cooperating with the European Union and established closer ties to Russia. Widespread protests lead to Yanukovych’s ouster as President, where he then took residence in Russia, and declared himself the rightful President of Ukraine. Russia meanwhile continued to push for changes in an independent region of Ukraine called Crimea. On March 16th, a referendum in Crimea was passed that would make Crimea part of Russia. This was not recognized by many countries around the world, including the United States, and as a minimum could lead to a civil war in Ukraine, and Russia, and worst case a significant war involving many countries around the world.5 The initial struggle hampered both the International and Domestic markets, as it appeared that war was imminent. As the situation calmed so did the global market with minimal sustained effect of the turmoil.

Legislative

One positive factor that happened quietly during the quarter from a domestic standpoint is President Obama signing legislation extending the federal debt ceiling until March of 2015. This has been an ongoing saga in the most recent years and at least now we will not have to worry about it for the near future.

What’s Next

The Fed has now tapered the QEIII Program 3 times, reducing the Bond re-purchase program by $30 Billion per month. The good news is that the market and economy are recovering and are becoming self-supporting. The downside is that the stimulus was a key contributor for 2013 and is now being tapered and eventually eliminated entirely. However, in a consumer confidence report released 2 weeks ago, American consumers are the most confident they have been in over 6 years.

How We Can Help You

Our education campaign for 2014 is “Financial Fitness”. In physical fitness, there are always new techniques and measures that can help you get in better shape. We use this same approach as it pertains to your Investments and Retirement. Are you doing what you need to do to give yourself the best chance for success? Will you live your retirement as you would like? If you have not reviewed your Investments, or do not have a succinct game-plan in place, now is the time to change that and take control of your financial future. We would encourage you to schedule a time to meet with us to review your account and give yourself the peace of mind knowing you are on the right path. Please feel free to contact me directly at david@pa401k.com.

1 US stocks end choppy quarter on a high note, By Jesse Solomon @JesseSolomonCNN March 31, 2014
2 LPL Financial Research, factSet Data System 03/31/14
3 Bloomberg
4 Best and Worst Stock Sectors For Q1, John Nyaradi, Wall Street Magazine
5 Crimea Referendum Vote On Joining Russia Scheduled For March 16 AP by TIM SULLIVAN and YURAS KARMANAU


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