My Bullish Case for Equities Heading Into 2014

By Matthew Pierce

Another month brought another new stock market high. In November, the bull market in US equities continued as the S&P 500 hit new three new all-time highs during the month and closed above 1800 for the first time on November 22.

It has been a great year for the US equity investor, and in this time of Thanksgiving and holiday celebration, all should rightfully celebrate. Wall Street's professionals should be happy with their year-end bonuses, and those investors who were willing to take big risks have been handsomely rewarded.

But I'm not sure that Main Street is paying attention.  Headlines reflect an undercurrent of worry about the economy, jobs, growth of income, government debt and bad fiscal management. Main Street is not listening to Wall Street talk about record corporate profits, earnings multiples that are not very expensive, modest inflation and improving economic trends.

Main Street is focused on jobs, corporate greed, and income disparity. Wall Street and Main Street are watching different channels. The trouble with this picture is that Main Street remembers the losses of 2008 too well, is still scarred by the Great Recession, and knows that good jobs have not magically appeared. Therefore, many on Main Street were not able or willing to participate in the great American equity rally.

But that may be changing, according to a Wall Street Journal article (“Stocks Regain Broad Appeal”, Nov 10, 2013). Individual investors are returning to equities.  Whether this is good or bad news for equities remains to be seen.

Many professionals believe that positive individual investor sentiment is a negative indicator for equity market growth. But other professionals take the view that the equity market is still relatively undervalued, even at this stage in a bull market.

So far, we have seen little to indicate that equities will not keep on trucking along. Main Street investors should have some of their savings in the global equity market, preferably in well-diversified risk-managed portfolios.

Global equities

Stock Indices	Nov 2013	Oct 2013	YTD 2013
Global, All Country (MSCI ACWI)	1.4%	4.0%	20.8%
US Large Cap (S&P 500)	3.1%	4.6%	29.1%
US Small Cap (Russell 2000)	4.0%	2.5%	36.1%
Non-US Developed (MSCI EAFE)	0.8%	3.4%	20.1%
Non-US Emerging (MSCI EMG)	-1.5%	4.9%	-1.2%
Gold Bullion	-5.4%	-0.2%	-24.7%
All returns through November 29, 2013

U.S. equity markets posted strong results in the 4th quarter to date with all major indices achieving measurable gains. Non-US developed markets also performed well, as European economic growth translated into stock market gains. Emerging markets lost ground in November after strong October and September returns.

Small cap stocks outperformed large cap stocks. Value and growth returned, although small cap growth performed slightly below small cap value. Gold bullion continued its year-long downward spiral losing more than 5% of value in November.

Domestic Fixed Income

Barclays Bond Indices	Nov 2013	Oct 2013	YTD 2013
US Aggregate	-0.4%	0.8%	-1.5%
US Treasury 7-10 yr	-0.9%	0.9%	-4.2%
US Treasury TIPS	-1.1%	0.6%	-7.2%
US Gov't / Credit	-0.3%	0.9%	-1.7%

 

10 Year Treasury Rates
Dec 31, 2012	1.78%
March 28, 2013	1.87%
June 28, 2013	2.52%
September 30, 2013	2.64%
November 29, 2013	2.75%
50 year average	6.66%
10 year average	3.52%

The US Bond market dropped marginally in November after rising somewhat in October. The 10-year Treasury interest rate edged upward to 2.8% at the end of November from 2.6% in October and September.

The continuing dominant driver of interest rate expectations remains the Fed's commitment to monetary stimulation through quantitative easing (“QE”), despite signs of an improving economy and a drop in joblessness in November to 7.0%.

Conditions are now sufficiently positive that the Fed could justify tapering QE at any of its next few meetings. Our suspicion is that there will be no change from current policy at least until Janet Yellen becomes chair of the Fed in January. Main Street concerns that tapering QE will halt the fragile jobs recovery will also likely keep the Fed from changing current policy in the very near term.

Summary

We remain positive on equity markets in general, and particularly relative to bonds, because of seasonal factors, improving economic news, record corporate profits and moderate earnings multiples.

But we also recognize that the US equity market is one exogenous shock away from a market correction and that at least one likely shock will occur when whispers of Fed tapering begin again, probably in early spring. That correction will cause Main Street great anxiety and give Wall Street another reason to buy on the dip. Until that occurs, we remain overweight equities. Keep on truckin'.

DISCLAIMER: The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable.  Past performance is no guarantee of future results.

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Matthew Pierce

Island Light Capital Corporation is an investment advisory and consulting firm that specializes in the development of optimally diversified investment…

The following article is from one of our external contributors. It does not represent the opinion of Benzinga and has not been edited.

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