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Pigs Get Fat

Happy New Year!  2013 was some year for U.S. stocks.  As measured by the S&P 500, December’s 2.3% upward move pushed the return on the benchmark index up to 32.4% for the year.  In 2013, stocks were up for 10 of 12 months producing an impressive 85% batting average.  For some context, over the past 25 years, the S&P 500 has been positive 18 times, for a 72% batting average.  During that span, the only year with a better record was 2006, when stocks rose in 11 of 12 months.  While these numbers are impressive, many investors have become conditioned to expect fits of volatility (stocks dropped 38.5% in 2008, and by 46.6% from 2000-2002) and were caught off-guard by the market’s recent strength.

In E.B. White’s Charlotte’s Web, Charlotte writes the message “SOME PIG” in her web in an effort to convince Farmer Zuckerman that Wilbur is special.  I suspect this market is special and like Wilbur it will endure.  In my opinion, what we have before us is not so much a bull market, rather something more akin to a pig market, if there is such a thing.  In my view, the market is nearly fully valued.  It is alive and well, but wallowing somewhat.  In keeping with the pig theme, I sense we will need to carefully root around for stocks that represent both value and opportunity.

As an investor, it is often difficult to separate one’s decision making from the animal spirits (John Maynard Keynes’ term) of the market.  All too often we base our investing on unrealistic expectations, or worse, what everyone else is doing.  The psychology of investing, somewhere between art and science, is where even the foremost investors can become stuck in their own rethinking.  At the moment, I agree some profit taking makes sense (the common worry is that overdoing it will only lead to ruin) yet I also believe the fundamentals are in place for the market to continue upward.

The stock market is forecasting good economic numbers (via its discounting function) in 2014.  The jobs numbers will continue to improve, interest rates will remain in check (and more importantly, the yield curve will maintain its positive slope), there will be no surprise changes in monetary policy from the Federal Reserve, and the U.S. Congress will not do any greater harm to the economy through their fiscal ineptitude.  As reported by The Bespoke Report – 2014, there has never been a recession in the U.S. that was not preceded by

a negatively sloped yield curve (long term interest rates lower than short term) so one can take some comfort we are not on the brink of another recession.  In addition, with the new all-time high in industrial production, “the economic recovery has now shifted from merely a recovery to outright expansion.[i]

The thing we have to fear, in my opinion, is the inevitable “unknown” event.  Call it a black swan or a shock, something will come along and jar investor confidence.  The news media spends mountains of time assessing the known – it’s the unknown that will change the market’s course.  We have to expect this.  And after so many months of positive returns, the rumblings of change, and the jolts of fear will be uncomfortable.  The market has not seen a 10% correction in a long time.  Our decision at that point is whether the event will lead to a directional change in the markets, or whether it’s simply a buying opportunity.

Our goal at the moment is to revise our sector weightings in our stock portfolios to emphasize where we think the greatest opportunities lie.  In my opinion, technology, telecom, industrials and financials (non-bank) are attractive.  Both health care and consumer stocks are interesting, but I’d prefer to wait for them to re-price.

The outlook for our other primary asset classes is mixed.  I expect only average returns from short to medium term bonds (5-10 year maturities).  I favor municipal and higher yielding corporates.  Interest rates will likely edge higher with the strength in the economy, but nothing like the dramatic shift that hit in May of 2013.  I think REIT’s will recover from a difficult year, despite rising cap rates, and I expect another strong year from MLP’s.  There is good reason to maintain a well allocated portfolio.

I am available to discuss your asset allocation, opportunities to take profits or to put new funds to work, as your circumstances dictate.  Please do not hesitate to call.  I am most thankful for a prosperous 2013 and looking forward to the challenges and the opportunities 2014 will bring.

Bruce Hotaling, CFA

Managing Partner

[i] The Bespoke Report – 2014, p. 89

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