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The end of a year always provides opportunity to see what transpired in the markets and perhaps learn a few things. A wise man once said investment knowledge is cumulative, which shouldn’t imply you can eliminate all future mistakes, but you can hope to lessen their occurrence.
Last year was another good one for U.S. stock investors, as the S&P 500 index rose 13.7 percent on a total return basis. That marks six years of positive returns at an annualized rate of 17.2 percent since the -37 percent shellacking stocks encountered in 2008.
Last year confounded the “experts.”
It is doubtful that any analyst predicted the interest rate on the 10-year Treasury bond would fall dramatically from 3.03 percent to 2.17 percent. (The yield dropped below 2 percent in the first week of 2015!). At the start of last year, the overwhelming sentiment among investors—me included—was for rates to rise in 2014.
The sharp drop in interest rates was instrumental in sending utility stocks rocketing up 24.4 percent for the best-performing stock sector for 2014. Again, I am sure no Wall Street strategist predicted utilities as the place to be.
And of course, the plunge in oil prices since summer was unforeseen by oil industry experts. Economists surveyed by the Wall Street Journal in January expected oil to end the year at $95 per barrel. Instead, the price has been cut in half, to about $49.
There was plenty to worry about on a global macro-economic and political perspective. However, U.S. stocks paid little heed to the continuing struggle of European economies, Russia/Ukraine, Islamic State, the never-ending Middle East instability and Ebola.
It turned out the United States was sort of the sheltered island in a troubled sea.
Developed global markets, excluding the United States, lost 6.4 percent, and emerging markets were off 5.6 percent. Foreign investors also had to fight upwind against a strong dollar, as investors sought a safe harbor in the world’s reserve currency.
This is not to suggest that we don’t have our own concerns at home. The Federal Reserve is plotting to raise interest rates and end its zero-interest-rate policy and quantitative easing programs. The falling interest rates on Treasury bonds and oil prices (deflationary) may throw a wrench in those plans.
On the other hand, the economy continues to improve. The drop in oil prices should provide a strong boost to consumer demand (inflationary). It is unclear how the Fed will maneuver policy in this tug of war between deflation and inflation.
Investors, though, should recognize a few things. After six years of strong market performance, stocks are not the bargains they once were. Various valuation measures point toward a more fully priced market. Price-to-equity ratios near 17 and a total stock market value to gross domestic product ratio of 125 percent serve up a few yellow lights.
At present levels, proceeding with cautious optimism while having some cash available to take advantage of opportunities is advisable.•
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Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.
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