U.S. financial assets delivered another year of strong investment returns as the economy finally exhibited signs of accelerating growth. The domestic economy has posted real GDP gains of at least 3.5% in four of the last five quarters, and although the fourth quarter of 2014 is unlikely to match this pace, U.S. economic activity is clearly gathering momentum.
Against this backdrop, U.S. stocks shrugged off a number of worrisome developments in 2014, including less monetary stimulus by the Fed, Russia’s invasion of Ukraine, and continued economic weakness in Europe. The S&P 500 Stock Index gained 13.7% in 2014 (dividends reinvested), and has delivered double-digit gains in five of the last six years. If you were daring (or lucky) enough to invest in the S&P Index at its nadir in March 2009, your money has more than tripled.
Fixed Income investors also experienced respectable gains. Investment grade bond portfolios delivered returns above their coupon interest, boosted by last year’s surprising decline in interest rates. Bold investors who ignored consensus forecasts of higher rates and bought long-term Treasury bonds enjoyed gains of more than 25.0%. Investors in shorter-term bonds experienced returns in the low-to-mid single digits. Municipal bonds did especially well, as higher tax receipts strengthened state and local balance sheets.
Equities overseas generally failed to keep pace with the U.S. Both the MSCI EAFE Index (measuring mostly European and Japanese stocks) and the MSCI Emerging Markets Index (weighted toward large developing economies such as China, India, and Brazil) posted negative returns in 2014 (in USD). The diverging market performance of these countries versus the U.S. reflected their disparate economic trajectories.
The big story roiling markets as 2014 closed was the stunning 46.0% decline in oil prices. Led by energy, the broad commodity index fell by17.0%, the fourth straight year of decline. While we believe lower energy prices is a net positive for the U.S. economy, the speed and magnitude of the decline will likely have unanticipated consequences. One consequence may be heightened geopolitical tensions between energy-consuming nations (e.g. U.S. and Europe) and energy-producing nations (e.g. Russia, Venezuela, and Middle East countries).
After several years of outperformance by U.S. stocks, conventional investment wisdom might argue for rebalancing portfolios toward asset classes that have lagged. Our philosophy is based on a diversified investment approach with modest tilts towards asset classes expected to deliver above-average risk-adjusted returns. On that score, we still see the best combination of supportive economic fundamentals and reasonable valuations in U.S. equities.
We are not abandoning other parts of the world; we simply believe the trends that propelled U.S. stocks strongly in 2014 are likely to remain in place for the foreseeable future. However, with short-term interest rates likely to rise this year, lower returns in U.S. stocks, accompanied by bouts of higher volatility should be expected. U.S. stocks will likely outpace their European counterparts and we anticipate only a modest rise in U.S. long-term interest rates, as low European bond yields anchor U.S. rates at low levels.
We wish our clients and friends a safe and prosperous 2015 and we thank you for your continued support.
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The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. This presentation is not an offer to buy or sell, or a solicitation of any offer to buy or sell any of the securities mentioned herein.
Certain statements contained herein may constitute projections, forecasts, and other forward-looking statements, which do not reflect actual results and are based primarily upon a hypothetical set of assumptions applied to certain historical financial information. Certain information has been provided by third-party sources, and although believed to be reliable, it has not been independently verified, and its accuracy or completeness cannot be guaranteed.
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There are inherent risks with equity investing. These risks include, but are not limited to stock market, manager, or investment style. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices.
Bonds and bond funds are subject to interest rate risks and will decline in value as interest rates rise.
Indices are unmanaged and one cannot invest directly in an index. Index returns do not reflect a deduction for fees or expenses.
Returns include the reinvestment of interest and dividends.
Investing involves risk, including the potential loss of principal. Past performance is no guarantee of future results.