While Stocks Boomed, Investors Sold Bond Funds

By Karen Damato, News Editor, Wall Street Journal

Stock mutual funds kept chugging along in the final quarter of 2013, wrapping up a very profitable year for investors. The average diversified U.S.-stock fund returned 8.8% in the three months through December, bringing the return for the full year to a rich 32.3%, according to Thomson Reuters Corp.'s Lipper unit.

With much of the 2007-09 bear market having dropped out of five-year returns, the longer-term record is looking sweet as well. For the five years through year-end, the average diversified U.S.-stock fund returned an average of 17.7% a year.

Returns on foreign-stock funds were more restrained than those of their domestic counterparts in 2013. The average international-stock fund returned 5.8% in the fourth quarter, for a 19.6% average for all of 2013, according to Lipper.

Funds focused on emerging-markets stocks were laggards, returning an average of 2.5% for the quarter, to end with an average return of minus 0.1% for the year.

Meanwhile, many bond funds posted negative returns for 2013. The most widely held variety, funds that focus on intermediate-term investment-grade debt, returned an average of 0.2% in the fourth quarter, to end with a negative 1.9% return for all of last year.

Among the hardest-hit bond varieties were funds that focus on Treasury inflation-protected securities. Losses on many TIPS funds exceeded negative 6% for the year.

On the winning side, funds that buy below-investment-grade, or "junk," bonds returned an average of 6.8% in 2013.

Funds related to gold didn't glitter. Instead, they crashed. Those holding precious-metals stocks lost an average of 49.0% last year, while funds offering more direct exposure to precious-metals commodities prices lost 24.9%.

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The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

 The Jacksonville Business Journal has ranked D2 Capital Management in the top 25 of Certified Financial Planners in Jacksonville.  The Firm is also a member of the Financial Planning Association of Northeast Florida, the Jacksonville Chamber of Commerce, the Southside Businessmen's Club, and the Beaches Business Association. 

How High Can U.S. Stocks go in 2014?

By Russ Koesterich, CFA, Chief Investment Strategist for BlackRock and iShares Chief Global Investment Strategist.

2013 was a great year for stocks, but less so for earnings. As a result, equity valuations rose sharply. Given higher multiples and the magnitude of last year’s rally, many investors are wondering whether the gains can continue, and just how high stocks can go this year.

I foresee U.S. equities posting more muted gains in 2014. Why? The interaction of two factors that defined the market last year – significant multiple expansion and higher interest rates – represents a headwind for stocks this year.

Most of last year’s stellar advance was powered by higher multiples. In other words, investors were willing to pay increasingly more for a $1 of earnings. Over the course of 2013 the trailing price-to-earnings (P/E) ratio on the S&P 500 rose from 14.2 to 17.50, a 22% increase. Based on P/E measurements, stocks are commanding the highest valuation since early 2010, when multiples were still high due to depressed earnings. Using a different metric, price-to-book, the S&P 500 is now trading at the highest multiple since before the financial crisis.

While I don’t believe that stocks are in a bubble, last year’s multiple expansion does matter for future returns. Historically, markets have done slightly worse in years following multiple expansion. Since 1954, the return, net of dividends, on the S&P 500 has averaged 5.85% following years in which stocks got more expensive. In contrast, the average return following multiple contraction was more than 10%. Admittedly, the results seem to be disproportionately impacted by a few bad years, such as 2000 and 2002. If instead of using average returns, you focus on the median – which is less impacted by outliers – the difference is smaller: 9% in years following multiple expansion and 12.5% in years following multiple contraction.

However, investors should still be a bit nervous for another reason. Not only did multiples rise last year, but interest rates increased as well. In the past, higher multiples and higher rates have represented a challenging combination. In those instances when multiples rose but rates were lower, the average return for the market was more than 9%, in-line with the historic average. In other words, to the extent that rates are dropping, rising multiples don’t represent the same degree of headwind as when rates are rising. However, in the 14 instances between 1954 and 2013 when multiples rose and interest rates rose, the average return on the S&P 500 in the following year was a relatively paltry 2.3%.

That said, I don’t believe that the U.S. market is necessarily condemned to a year of near zero returns. I expect U.S. stocks will finish 2014 with a mid- to high-single digit gain. First, rates are rising from unusually low levels. The yield on the 10-year note is still barely 3%, well below its 20-year average of 4.5%. At these levels, bonds still represent little competition for stocks. Second, a stronger economy this year should translate into faster earnings, which means stocks can advance without a further jump in valuations. Still, last years’ multiple expansion and higher rates arguably constitute a yellow flag for U.S. stocks. Given this, I continue to advocate that investors raise their exposure to international markets and focus on cheaper parts of the U.S. market, such as large and mega cap stocks and the technology and energy sectors.

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The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

 The Jacksonville Business Journal has ranked D2 Capital Management in the top 25 of Certified Financial Planners in Jacksonville.  The Firm is also a member of the Financial Planning Association of Northeast Florida, the Jacksonville Chamber of Commerce, the Southside Businessmen's Club, and the Beaches Business Association. 

Digital Dividends

By Todd Shriber, ETF Trends

Investors can play the theme of growing tech dividends with the First Trust NASDAQ Technology Dividend Index Fund (Nasdaq: TDIV).

“Many of the underlying companies in TDIV are in a more mature phase of their business cycle which allows them to distribute earnings while still seeking long-term growth,” according to FMD Capital.

TDIV holds both NASDAQ and New York Stock Exchange-listed firms and its 12-month distribution yield of 2.43% is considerably higher than that of the NASDAQ 100. Still, some of the NASDAQ’s most prominent names that have recently matured into legitimate dividend stocks are found among TDIV’s 87 holdings.

That roster includes Dow components Intel (Nasdaq: INTC), Cisco (Nasdaq: CSCO) and Microsoft (Nasdaq: MSFT). TDIV gained 23.1% last despite, getting little help from Apple and being home to International Business Machines (NYSE: IBM), one of the Dow’s worst performers in 2013. IBM and Apple combine for almost 16% of TDIV’s weight. TDIV offers another advantage.

Tech companies “have low debt ratios and offer exposure to businesses that aren’t as susceptible to interest rate risk as utilities or telecommunications stocks,” according to FMD Capital. Historically, tech is one of the top-performing sectors when interest rates rise.

There is more to the tech dividend story. Investors have shown a willingness to pay up for expensive defensive sectors such as consumer staples and utilities because of past dividend growth from some of those companies, but the phenomenon of tech dividend growth is still new. That means some investors still may not realize the potential for substantial dividend growth from the tech sector going forward.

For example, in 2013, the average dividend increase by Apple, Cisco, Microsoft and IBM was 17.6%.

“Historically, for example, technology companies have been associated with reinvesting the bulk of their profits into their businesses to finance future growth, but more recently, some have favored share buybacks, dividend initiation or dividend increases. Since this trend in technology stocks is fairly recent (Cisco just began paying in 2011, for instance, and Apple in 2012), backward-looking dividend growth screens with five-, ten- or twenty-year periods may not fully capture these dividend initiations or increases,” said WisdomTree Research Director Jeremy Schwartz in a note published in October 2013.

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First Trust NASDAQ Technology Dividend Index Fund (TDIV) is a component of the D2 Capital Management Multi-Asset Income Portfolio. 

Disclosure:  I own the D2 Capital Management Multi-Asset Income Portfolio

The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

 The Jacksonville Business Journal has ranked D2 Capital Management in the top 25 of Certified Financial Planners in Jacksonville.  The Firm is also a member of the Financial Planning Association of Northeast Florida, the Jacksonville Chamber of Commerce, the Southside Businessmen's Club, and the Beaches Business Association. 

3 Bond Strategies for the New Year

By Matt Tucker, CFA, iShares Head of Fixed Income Strategy.

In a recent report, I took a look back at the fixed income strategies that I proposed at the beginning of 2013 to see how my ideas fared.  In some ways, the year shaped up much the way I expected with modest economic growth and the Fed maintaining their quantitative easing program.  However, while the Fed’s actions kept short term interest rates low, the Fed’s general tone and guidance made investors nervous, causing longer term rates to rise – and bond portfolios to suffer.

These events were a great illustration of how forecasting the market environment is not just about data analysis, but also very much about investor sentiment.  With the Fed continuing to be active with QE, what they say is in some ways as important as what they do.  This should continue to be a significant theme in the New Year.

So what’s on tap for bond markets in 2014?  Like last year, it will likely be all about slow growth and policy-driven markets.  The Fed has announced that it will begin to taper its bond-buying program in January, which should continue to drive up the rates on 5+ year bonds.  Meanwhile, the Fed Funds rate will probably remain zero for the year, anchoring short term fixed income yields.  Finally, inflation should remain close to historic lows, and volatility will once again be front and center.

With these considerations in mind, I’ve once again gathered my three current favorite strategies for bond investors to consider – just in time for 2014:

Continue to shorten duration.  The 2013 bond strategy of the year was, without a doubt, duration rotation.  Essentially, investors anticipating a rise in rates responded by shortening the duration of their fixed income portfolios.  Even though the Fed has begun to taper, we would expect this trend to continue for a while.  But investors should keep in mind that Treasury rates are approaching fair value given current levels of growth and inflation.  Unless one of these two factors spikes in 2014, the rate increases we do see are likely to be more modest than what we saw in 2013.  And the trend towards higher interest rates may slow down significantly in the second half of 2014 when tapering brings the QE program to a close.

Step out of cash.  With short-term interest rates near zero, investors are receiving a negative real return on cash investments after inflation is factored in.  While no investment is as safe as cash, short duration bonds offer relatively low interest rate risk with the opportunity for a higher yield than cash.  This is likely why we’ve seen many investors this year use short duration ETFs as a way to toe-dip back into the market.

Consider munis – but proceed with caution.  In a market where it’s hard to find yield, munis should continue to be attractive on a tax-adjusted basis.  However, munis are extremely rate-sensitive so will react to every bump in the road as rates continue to climb – securities on the shorter duration end of the spectrum should have an easier time. We also will likely see more volatility on the back of further news on Puerto Rico and other potential credit issues, muni bond investors need to expect this.

No matter what your outlook is, it’s always important to consider what role bonds play in your portfolio before choosing a fixed income strategy.  Are you seeking yield? Do you want more portfolio stability?  How about diversification?  If you continue to keep your objectives in mind, your bond investments should serve you well throughout 2014 and beyond.

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The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

 The Jacksonville Business Journal has ranked D2 Capital Management in the top 25 of Certified Financial Planners in Jacksonville.  The Firm is also a member of the Financial Planning Association of Northeast Florida, the Jacksonville Chamber of Commerce, the Southside Businessmen's Club, and the Beaches Business Association. 

Slow and steady for economy & stocks

By Robert C. Doll, Chief Equity Strategist and Senior Portfolio Manager at Nuveen Asset Management.

Economic growth was slow but stable during a year in which a federal government shutdown lasted for 16 days and Detroit filed for bankruptcy. The unemployment rate fell to the lowest in five years, to approximately 7% from 7.9% to approximately, as a result of modest job growth and declining labor participation (a 35-year low).

A significant economic head wind was fiscal tightening through a substantial tax increase and spending restraint (sequestration). This may have cost the economy nearly 1.5% in growth. An encouraging bipartisan deal helped fund the government through spending reductions.

Monetary policy supported global growth. In late spring, the Federal Reserve announced it was contemplated tapering its fixed-income purchases, causing a 100-basis point rise in interest rates and creating turmoil in India and Brazil. Although global growth was softer than expected, equity markets performed well. Emerging markets experienced weakness in growth, commodity prices, credit and liquidity. Europe began to emerge from recession with reduced tail risks, Japan benefited from monetary and fiscal policy stimulus, and China engineered a successful soft landing despite remaining imbalances.

Our 2013 theme of a muddle-through economy and grind-higher equity market was influenced by equity valuation (Price to Earnings) expansion, perhaps because of reduced uncertainty and rising confidence. We see these factors continuing in 2014.

2014 Ootlook - We expect economic growth will be broader and stronger, yet remain moderate for the United States and around the world. Macroeconomic risks are diminishing as economies improve, which may help reduce fear and strengthen confidence. U.S. fiscal drag is lessening, Europe is emerging from recession, Japan's deflationary head winds are diminishing, and China is showing signs of stabilization. Improving sentiment for U.S. corporations, along with strengthening consumption, should lead to an increase in capital spending and a relatively stronger growth trajectory.

This transition to self-sustaining growth should provide the necessary acceleration in revenue and earnings growth.

Fed tapering likely will be slow and incremental, with U.S. and global monetary policy geared toward stimulating growth. As a result, we anticipate the bond market will continue to experience a gradual climb in interest rates. We believe rising bond yields are not a head wind for equities as long as economic conditions continue to improve.

Skepticism about the durability of the equity rally exists as many argue that stocks have become expensive and profit margins are unsustainably high. We do not think these potential head winds will prevent gains, but instead limit them, and perhaps cause volatility. Inflation is unlikely to be a problem, and deflation is a threat in Europe. Equities are vulnerable to a correction given recent strength and some technical deterioration, but we continue to favor a moderate pro-growth equity posture.

The U.S. equity market should continue to grind higher as a result of central bank liquidity, modest economic acceleration, quiet inflation and an improving fiscal situation. Expect the U.S. and global economies to improve in 2014, encouraging acceptable growth in revenue and earnings. The gradual improvement is not likely to threaten the unprecedented global monetary experiment that has helped underpin the rise in equity valuations. Even though equities may still advance, run-ups since 2009 and throughout 2013 have reduced our forward view for annual returns to mid- to high-single digits. We prefer companies with positive free cash flow profiles, low valuations, economic sensitivity and/or above average secular growth.

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The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

 The Jacksonville Business Journal has ranked D2 Capital Management in the top 25 of Certified Financial Planners in Jacksonville.  The Firm is also a member of the Financial Planning Association of Northeast Florida, the Jacksonville Chamber of Commerce, the Southside Businessmen's Club, and the Beaches Business Association. 

January 2014 Client Letter

Happy New Year.

            Well, when all was said and done, 2013 was a rather exceptional year for investing.  Across the board markets rallied.  The Standard and Poor’s 500 finished its best year since 1997 and the Dow Jones Industrial Average finished its best year since 1995.  Both indexes closed at record highs for 2013.

            So will this very good fortune continue into 2014?  History tells us “no.”  Since 1927, there have been 23 years that the markets increased by 20% or more.  But only once did the following year beat its predecessor.  On the other hand, in those years where the S&P 500 finished the year 25% higher, 66% of the following year also ended in positive territory. 

More likely, 2014 will continue forward movement, but at a much more measured pace.  Analyst estimates point to gains ranging from 4% to 10% for 2014.  Still that is not bad considering that the average annual 142 year return for the market is 8.8%.

            Positives for 2014 include increasing optimism about the U.S. and global economies.  In the U.S., interest rates will remain low, inflation is in check, employment is up, the housing market continues to improve, and consumer and corporate spending is increasing.  All of these bode well for continued domestic economic acceleration.  In addition, with $10 trillion still sitting in retail investor cash accounts, as that money moves into the markets, that also could drive stocks higher.

            Overseas, Europe is officially out of recession and China’s annual growth is expected to remain above 7%.  Both are indicative of increasing global recovery.

            But lest we get overly optimistic and confident about 2014, I expect the run-up we enjoyed in 2013 will regress some in 2014.  In 2013, we only had five pullbacks of 2% or more.  Additionally, it has been 27 months since the S&P 500 corrected down 10% during this bull market.  The average periodicity for such correction is 18 months.  Profit taking and the “reversion to the mean” where it comes to stock prices and valuations could result in a pullback between 5%-10%.  If and when that happens, it offers an ideal time to make further contributions to your accounts.

            And be prepared for some more volatility in 2014.  This is normal and would likely be related to financial or political issues in Washington, Europe, China, and the Middle East.

The views expressed here are that of myself and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

 The Jacksonville Business Journal has ranked D2 Capital Management in the top 25 of Certified Financial Planners in Jacksonville.  The Firm is also a member of the Financial Planning Association of Northeast Florida, the Jacksonville Chamber of Commerce, the Southside Businessmen's Club, and the Beaches Business Association. 

A Look Ahead at 2014

By Russ Koesterich, CFA, Chief Investment Strategist for BlackRock and iShares Chief Global Investment Strategist.

As we head into 2014, it’s time for my annual look forward.

So what am I calling for in 2014?  I’m sticking with many of the same themes as last year, with a couple of critical tweaks.

From an Economic Perspective: From an economic perspective, I expect growth to pick up modestly, both in the United States and globally. In 2014, I expect the U.S. economy will edge past the 2% growth rate of the past couple of years and come in around 2.5% to 2.75%. Global growth should accelerate from 3% in 2013 to around 3.5% next year. Despite somewhat faster growth, 2014 is likely to be another year of low inflation in most developed countries.

Although the Federal Reserve (Fed) has begun its long awaited taper, policy remains accommodative and supportive of the economy. Stronger household balance sheets also represent a tailwind.

I also expect an increase in real interest rates thanks to slightly better growth, though the Fed likely keeping the fed funds rate close to zero throughout 2014 should keep the rate rise modest. I would look for an increase of around 0.5% for the 10-year Treasury over the course of next year.

From an Investment Perspective: Against this economic backdrop, I continue to advocate that investors overweight stocks in their portfolios. Equities may not be as inexpensive as they were a year ago, but they remain more attractive than bonds and cash. That said, I do expect more market volatility next year, and I believe that investors should be selective within equity markets. In particular, I think international stocks and emerging market equities are worth investor attention, as they both appear more reasonably priced than U.S. equities.

Meanwhile, there are few bargains in fixed income markets. With rates likely to rise and inflation still low, I still advocate underweighting long-dated Treasuries and Treasury Inflation Protected Securities (TIPS), and sticking instead with fixed income credit sectors, including high yield bonds. Additionally, I continue to believe that muni bonds look attractive.

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The views expressed here are that of myself or the cited individual or firm and do not constitute a recommendation, solicitation, or offer by myself, D2 Capital Management, LLC or its affiliates to buy or sell any securities, futures, options or other financial instruments or provide any investment advice or service. D2, its clients, and its employees may or may not own any of the securities (or their derivatives) mentioned in this article.

 The Jacksonville Business Journal has ranked D2 Capital Management in the top 25 of Certified Financial Planners in Jacksonville.  The Firm is also a member of the Financial Planning Association of Northeast Florida, the Jacksonville Chamber of Commerce, the Southside Businessmen's Club, and the Beaches Business Association.