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A Good Year to Invest

It was a great year for equity investors.

It was a great year for equity investors.

In spite of a slow and lackluster U.S. recovery, recessions in China and Japan, threats of a complete U.S. government shutdown, lingering euro zone debt problems, climbing interest rates, worsening turmoil in the Middle East and stock market glitches, the markets still managed to gain altitude as stocks tripled in value from their lows of March 2009.

Estimated GDP growth averaged 2.3 per cent for the year, compared to 2.0 per cent for the prior two calendar years. The improvement came in Q3, when growth jumped to 4.1 per cent. Despite this recent spark, the recovery that began in 2009 is one of the weakest in the postwar era.

Positive signs appeared during the second half of the year, including job market gains, lower inflation, rising wages, a revival in manufacturing, stronger auto sales, increased consumer spending, improved corporate balance sheets and sustained business profits. The housing market also improved, although most of the gains in home prices and sales came earlier in the year. Rising stock prices and housing prices helped boost household net worth to a record level in Q3.

Strong business fundamentals helped
In 2012, U.S. corporate profits reached their highest level (as a share of GDP) in the post-war era. Few analysts expected a repeat in 2013; through Q3, however, U.S. businesses were on track for another strong year. Observers attribute rising profitability in a sluggish economy to productivity gains, falling wages and relentless cost cutting among businesses. Rising profits have helped drive stock prices, but companies have been stockpiling the cash rather than reinvesting or distributing it.

It was the busiest year for initial public offerings since the financial crisis began, with a 59 per cent jump in the number of U.S. offerings and a 31 per cent increase in cash raised compared to 2012.

The “T” word kept investors on edge
After being introduced in September 2012, and in the face of constant speculation about its demise, quantitative easing maintained its $85 billion/month pace right up to the December 18, 2012 policy meeting when the “T-word” (tapering) was finally announced.

To ease worried investors, the Fed quickly announced that tightening remained far off and that U.S. unemployment rates would have to sink below 6.5 per cent before the process would begin

Generous money policies at other central banks also fueled the equity markets.

Throughout the year, the U.S. Federal Reserve Board stood beside equity investors to drive up stock prices while keeping interest rates low.

It also helped to produce double-digit returns from developed country equities, (which was really not news) as the major developed country stock markets have delivered double-digit annual returns in four of the past five years,  says Stephanie Flanders of J.P. Morgan Asset Management.

Bonds fell out of favour
Stocks out-performed bonds as many bond investors fled investment-grade debt, especially bond funds and bond Exchange Traded Funds, resulting in the worst year for that asset class since 1980, and only the third time in 34 years the class finished the year in the red says Thomas Kenny at About.com Bonds.

Well-diversified bond investors chose, for example, individual bonds versus bond funds, and fared better than others despite the upward swing in long-term Treasury yields.  The main culprit behind the bond market’s generally weak performance was the December tapering announcement combined with more robust economic reports, which propelled the yield on a the 10-year note over three per cent, by year-end. Corporate bonds also lost altitude due to the increase in Treasury yields.

During 2013, the yield on the 10 ten-year Treasury note climbed from 1.76 per cent to 3.01 per cent―its largest increase since 2009. Rising interest rates left U.S. fixed income indexes with either flat or negative returns, with longer-term and higher-quality bonds declining the most. Returns in the international bond markets were mixed and emerging market bond index returns were negative.

Canada’s economic growth was muted in 2013
The year brought modest gains for the Canadian economy. Real GDP grew at an estimated 1.7 per cent annualized rate in 2013, close to the 1.8 per cent rate logged in 2012. Slowing consumption, the sharp rise of the ratio of household debt to disposable income, modest wage and job gains, and earnings weakness (especially within the manufacturing and resource industries) conspired to keep Canadian economic growth muted.

Despite these mixed economic results, Canadian stocks delivered positive performances, although returns were below those of the U.S. and most developed markets. For the calendar year, the S&P/TSX Composite Index delivered a 12.99 per cent total return and the S&P/TSX 60 Index had a 13.26 per cent return. Most of the market gains came in the last five months of the year.

Canadian fixed income returns were mixed, with short-term indexes delivering higher returns than long-term benchmarks. The DEX Universe Bond Index returned -1.19 per cent, the DEX Short-Term Bond Index 1.74 per cent, and Canadian T-bills 0.96 per cent  for the year. The Canadian dollar began 2013 at parity with the U.S. dollar, but declined 6.4 per cent over the year—its weakest performance since 2008.

Global diversification: a winning strategy in 2013
In my article last year summing up 2012, I suggested that diversification is a risk management technique that mixes a wide variety of investments within a portfolio. It is worth repeating that a portfolio containing different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio. It’s a case of safety in numbers – well-considered numbers, that is.

Global investing is a large part of portfolio diversification. By investing overseas, you have the opportunity to invest in dynamic international companies that may be growing faster than their Canadian or U.S. counterparts.

It is worth repeating that while foreign stocks and bonds are typically more volatile than say, U.S. stocks, adding international exposure to a portfolio will normally reduce volatility and risk within the portfolio without lowering returns. A portfolio of 80 per cent U.S. stocks and 20 per cent international stocks will likely have similar yields with less risk than a portfolio of 100 per cent U.S. stocks.

Global diversification was again a winning strategy for investors in 2013, and the U.S. was especially kind to equity investors. The proof of this lies in the fact that all major U.S. market indices had substantial gains for 2013. The S&P 500 logged a 32.39 per cent total return. The NASDAQ Composite Index gained 40.14 per cent and the Russell 2000, a popular benchmark for small company U.S. stocks, returned 38.82 per cent, its biggest gain since 1993. The stock market’s strong performance came with lower volatility, as gauged by the VIX, which fell for the second straight year to reach its lowest level since 2006.

Non-U.S. developed stock markets also experienced strong gains. The MSCI World ex USA Index, a benchmark for large cap stocks in developed markets outside the US, returned 21.02 per cent. The small cap and value versions of the index gained 25.55 per cent and 21.47 per cent, respectively. Emerging markets were the exception to the global market advance. The MSCI Emerging Markets Index returned -2.60 per cent, with the small cap and value sub-indices returning 1.04 per cent and -5.11 per cent, respectively.

Among the equity markets tracked by MSCI, all countries in the developed markets had positive total returns (gross dividends; local currency), although the range of returns was broad (from 0.25 per cent to 47.35 per cent). Ireland, Finland and Spain were the highest performers; Singapore, Australia and Canada were the lowest performers. In the emerging markets tracked by MSCI, most countries logged negative total returns and the dispersion of returns was broad, ranging from -30.70 per cent to 25.98 per cent.

The debate about whether global equity markets would maintain their momentum through 2014, continued as 2013 drew to a triumphant close. Yet government and personal debt remained high, ultra-low interest rates were unsustainable and many wondered how corporate profit margins could continue to grow.

As the markets advanced, the opportunity was presented to rebalance portfolios.  We continued to utilize our non-emotional  empirical process which does not try to forecast the future and believes that markets make money over time. It is important to maintain long term goals with the rebalancing of portfolios. This year, taking a profit in equities and buying the underperforming assets of fixed income was prevalent.

Now is the time to look to top-quality financial advisors who understand your business and your lifetime goals. Having a plan will be to the benefit, certainly, of you and most importantly, your beneficiaries.  Markets like those seen in 2013 help keep a plan on track, and working with an advisor will help keep you on track regardless of what happens through the year.

Jim Sanderson is a senior wealth advisor with over 28 years in the investment services industry. The Jim Sanderson Group at Scotia McLeod specializes in creating and distributing wealth for successful individuals and corporations in the aggregate and road building industries across Canada. He helps his clients supported by a team of experts in insurance, merchant banking, trust and estates. Jim can be reached at jim.sanderson@scotiamcleod.com  Call at (416) 945-4844 or visit his website at www.jimsandersongroup.com .