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Health & Fitness

David Joy: A few end-of-year observations

Equity investors are mostly sorry to see 2013 go. But this year has been kindest to those with exposure to developed economies still recovering from the financial crisis, and supported by aggressive monetary policies. With only a few hours of trading left in the year, the S&P 500 is up 29%. That would make this the best year since the 30% gain in 1997. From its low in March 2009, the index has risen 175% in price terms.

And this year has not been just a story of U.S. returns. The MSCI EAFE index has climbed 19%. Europe is higher by 21%, while Japan is up 24.

But not all countries enjoyed the same kind of returns. Commodity-centric markets struggled as the price of many raw materials slumped. The Dow Jones-UBS commodity index has fallen 8% this year. Canadian stocks have risen just 2%, while Australia is down 1%.

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A similar story has played out in many emerging markets. The MSCI EM index is down 5.5%. Brazilian stocks are down 19%, Chile is down 23%, and Peru is down 32%. Indonesia is down 27, and Malaysia is up just 4%. Russia is down 3%, and China is flat. The threat of less aggressive monetary policy in the U.S. going forward has also pressured these markets, as have inflationary pressures and the need in many cases for structural reforms.

But, even if one chose not to try to identify the winners and losers at the country level, it was still quite a gratifying year. The MSCI All-Country World index is up 20%, and 133% from the 2009 low. The five-year annualized return in price terms is now 12.3%. And even the ten-year average return is a decent 4.9%. For the S&P 500 the numbers are slightly better at 15.1% for five years and 5.0 for ten years.

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Needless to say, the experience for bond investors has been far less gratifying this year. So far, the Barclays Aggregate bond index is down 2.1%. Longer maturity Treasury bonds suffered double-digit declines as the yield on the 30-year bond climbed a full percentage point. Notably, the ten-year average annual return for bonds now closely resembles that of stocks, while the five year average lags significantly. Through the end of November, the five-year average return of the Barclays Aggregate is 5.3% and the ten-year is 4.7.

In contrast, high yield bonds fared considerably better. The Barclays High Yield index is up 7.3% for the year. In fact, longer-term high yield bond returns not only exceed those for high grade bonds; they surpass even those for equities. The five-year average annual return for the Bank of America Merrill Lynch High Yield Master II index is close to 20% and the ten-year average is close to 9%.

Comparing historical trends
The folks at Cornerstone Macro Policy Research point out that the presidential cycle anticipates modest returns in the year ahead. Based on observations dating back to 1945, the second year of a presidential term typically produces the lowest average annual returns for all presidents of just 5.3%. The experience is worse for Democrats at 3.0%, versus 7.4 for Republicans. The silver lining is that year three on average produces the best returns of 16.1% for all presidents, including 15.2% for Democrats.1
 
Lastly, back in September, Ned Davis Research produced an interesting report comparing this market recovery, dating back to 2009, with the three secular, or long-term, bull markets they have identified in the past 90 plus years.

One point of similarity so far has been the average annual return four years from the start of the advance. In this recovery, at the time of the report’s publication, the average annual return from the March 2009 low was 22%. This compares with the 22% return during the first four years of the 1921-1929 secular bull, the 22% average first four year gain in the 1942-1966 bull, and the 24% average of the first four years in the 1982-2000 bull market.

Other points of comparison relate to attractive valuations, especially relative to bonds, declining correlations among asset categories, rising confidence and falling unemployment, loose monetary policy, declining budget deficits, improved equity fund flows, and so on.

With the exception of the 1920s bull market, the second four years of equity returns were less robust than the first four. In the 1920s the second four years produced average returns in the Dow of 27%, versus 22% in the first four. The 1940s bull saw average annual returns fall to 1% from 22, and the 1980s saw a decline to 10% from 24. And it is important to point out that cyclical, or shorter-term, bear markets do occur within secular bulls, but they tend to be short and shallow like the 20% decline between April and September 2011, and less frequent than during secular bear markets.2

Whether the next four years continue to resemble these historical experiences remains to be seen. A lot can change. But, at the very least, the comparison provides something interesting to ponder.

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1 Cornerstone Macro: The Presidential Cycle; Laperriere, Perli, and Turner; December 27, 2013.
2 Ned Davis Research: New Era Confirmation-Passing the Duck Test; Hayes, Sellers, and Nath; September 10, 2013.

 

Disclosure

The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Ameriprise Financial associates or affiliates. Actual investments or investment decisions made by Ameriprise Financial and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances. Investment decisions should always be made based on an investor's specific financial needs, objectives, goals, time horizon, and risk tolerance.

The S&P 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill.

Morgan Stanley Capital International EAFE Index (MSCI EAFE), an unmanaged index, is compiled from a composite of securities markets of Europe, Australasia and the Far East.

The Dow Jones-UBS Commodity Index℠ is composed of commodities traded on U.S. exchanges, with the exception of aluminum, nickel and zinc, which trade on the London Metal Exchange (LME).

The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets.

The MSCI World Index is a free-float weighted equity index. The MSCI World Index (MXWO) includes developed world markets, and does not include emerging markets.

The Barclays Aggregate Bond Index is a market value-weighted index that tracks the daily price, coupon, pay-downs, and total return performance of fixed-rate, publicly placed, dollar-denominated, and non-convertible investment grade debt issues with at least $250 million par amount outstanding and with at least one year to final maturity.

The Bank of America Merrill Lynch High-Yield Bond Master II Index is an unmanaged index that tracks the performance of below investment grade U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market.

The Barclays High Yield Index covers the universe of fixed rate, non-investment grade debt. Pay-in-kind (PIK) bonds, Eurobonds, and debt issues from countries designated as emerging markets (e.g., Argentina, Brazil, Venezuela, etc.) are excluded, but Canadian and global bonds (SEC registered) of issuers in non-EMG countries are included. Original issue zeroes, step-up coupon structures, and 144-As are also included.

It is not possible to invest in an index.

Investment products are not federally or FDIC-insured, are not deposits or obligations of, or guaranteed by any financial institution and involve investment risks including possible loss of principal and fluctuation in value.

Brokerage, investment and financial advisory services are made available through Ameriprise Financial Services, Inc. Member FINRA and SIPC.

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