Well, we have a quarter of 2014 in the books and we appear to be going at a tortoises pace. Despite a bit of wavering volatility, US stock indexes went almost nowhere the first quarter of this year. Year to date, the Dow Jones Industrial Average™ is down a fraction and the S&P 500® is up less than two per cent year to date. So, after a blistering 2013, we seem to be looking at a market that is fully priced and taking a much needed rest.
Developed international stocks were also up a very small amount while emerging markets continued to struggle. After a year in which diversification only served to diminish your returns on US stocks, the quarter did shine a light on the continued value of diversification in a portfolio.
Commodity indexes led the way with larger returns than US stocks, a big reversal from their losses in 2013. US fixed income holdings also had positive performance for the quarter after a negative 2013. Amongst leading bond categories were those which did the worst last year including Municipal bonds, long term US Treasuries, and preferred stocks.
So, does this foreshadow much about the rest of the year? To be blunt, we have no idea. We believe that short term market movement is determined by future and unpredictable news stories. Longer term markets produce returns based on current valuations and future earnings including dividends and interest.
Those elements tell a cautionary tale at this point. We have not had a real correction to stock markets in the past year and a half. With current valuations at or above normal, one might suspect a correction within the next year or two. Recessions normally occur every 8-10 years, so somewhere down the road earnings will take a tumble from their current growth pattern.
We are not predictors and are not trying to be gloomy in our outlook. However, we do feel caution and reality need to be in investor’s minds going forward. We do not expect to have above average returns in either US stocks or fixed income over the next five years based on current valuations and anticipated earnings.
A well-diversified portfolio remains the best way to manage your risks and capture some of the gains available to investors. The current pause in the climb of US stock prices seems like a good thing to us in terms of the long term returns that we expect. Finally, avoiding a bubble would be a good idea though who knows if the market will manage to accomplish that.
By Ted Schwartz, CFP©