2013 Annual Summary/2014 Outlook

DelChina Thompson |

“The Year of the Horse”

What to expect in 2014

For those of you who are new clients, or those who are reading this note for the first time, I should explain. Each year I sit and write you a note. In it, I try to analyze the prior year in my own words so that you have an idea of what environment your accounts with me were active in. I also try to give you an idea of how I see the investment landscape as we enter the New Year. In our brief discussions through out the year time does not permit me to extol all of my thoughts and analysis with you. My hope is that the 20 minutes or so, it takes you to read this note helps you gain a better feel for my view of the investment climate and how I think about Investment Markets, in general. Welcome aboard, or welcome back and I welcome your feedback!!!!


Here are the official returns from 2013

Dow Jones Ind. Average (U.S. Stocks)   +26.5%

S&P 500® (US. Stocks)                  +29.60%

MSCI EAFE® (Intl Stocks)          +19.43%

MSCI REIT (Real Estate)                 -1.39%

Aggregate U.S. Bond Index              -2.03%

Gold                                                  -27.88%

(source:Wells Fargo Advisors LLC)

(For those of you wishing for the abridged version of this note, feel free to jump straight to the summary which starts on page 8. For everyone else, we have lots to discuss it has been a whole year. So, let’s jump right in!!!)

What Happened in 2013??

In a short sentence-Not Much!!! Oh, we had the brief Government shutdown because of our all too normal occurrence of dysfunction in Washington. But, compared with our economic and financial worlds since 2008, last year turned out to be a welcome respite. In my letter last year I spoke of a “return to boring”. That’s when financial news shows up on page 7 or 8 of the newspaper. Hopefully, 2013 turns out to be the beginning of a long run-Return to Boring. 


I have been watching for a rise in interest rates for the last 3 years. Indeed as far back as the 2010 Noland’s Notes I have been on alert for the eventual increase in rates. (Remember, when interest rates rise, bonds prices decline). Finally, long term interest rates ended the year much higher than where they started the year. This is why Bonds had a negative return last year. Also, we got a long awaited recovery in the housing markets. I am sure everyone everywhere knows about the housing recovery by now. Fortunately, 2013 marked the second consecutive year of recovery. I think the thing that surprised people was how calm things were. The sedate economic environment led to positive investment returns once again. I suppose the largest contingent of disappointed investors were the Gold Bugs. In recent years gold has gained many bandwagon riders. I am sure that had a lot to do with both our economic crisis in 2008 and gold’s spectacular returns over the last several years. Alas, 2013 saw a reversal of all that the gold bugs hold dear: a Lack of a real crisis, Low inflation, no panic and a rising stock market. Given those facts it is no wonder that Gold was one of the worst performing investments of 2013. 

Here is what I will be watching in 2014

Bonds & Cash

In recent years I have spoken ad nauseam about the trillions sitting in cash earning paltry interest rates. Indeed, at last check money market rates were well below 1%. There has been some movement out of cash and bonds, but not much. Not enough. Since 2007 there has been $1.3 Trillion added to Bonds and only $498 Billion added to stocks (J.P. Morgan). With the second consecutive year of positive returns in the markets and 2013 being a year of relative calm I will be watching to see if investors speed the pace of moving from more conservative investments to the stock market. It is not only families that are holding cash, but corporations are the biggest holders. Moody’s reports that there is over $1.4 Trillion sitting on corporate balance sheets, which is a record amount. You’ll notice there has not been a lot of corporate expansion or corporate hiring. Instead companies have been using the cash for large dividend increases and share buybacks. This has also been supportive of stock prices. However, what really gets the market going is M&A (Mergers & Acquisitions). When we see the pace of companies buying and merging with other companies that will send another signal that we are getting back to normal. It would be nice to see companies start expanding again, hiring again and starting new projects. I’d be shocked if we saw a bunch of that this year. I’d bet we get corporate mergers first. It’s a much faster way to grow and purchase targets aren’t all that expensive. If they fund the company purchase with debt, while rates are low, it won’t cost them much in interest payments as interest costs are tax deductible for them.


The New Tax Rates

One of the things that always surprises me when I meet with new clients is how they answer the question of “What is your major financial concern?” I usually get a range of answers: Having enough Income in Retirement, Running out of money, paying for my child’s college expenses, etc. I don’t know if I have ever heard anyone mention our least favorite Uncle-Uncle Sam the tax man. Taxes are such a huge expense that nearly everything else pales in comparison. A major point of contention during the 2012 election was the disagreement over taxes. Remember phrases like; “We shouldn’t be giving tax breaks to millionaires and billionaires” and “Everybody should be paying their fair share.” (Now stay with me for a moment. I apologize in advance for this trip through U.S. tax history, but it is wholly necessary for where I’m going). After the 9/11 terrorist attacks George Bush, along with our Congress set out to stimulate our economy in the after math of that event. One of the strategies was to lower taxes to stimulate the economy.

  • Income taxes were lowered-the top rate decreased to 35%
  • There was a 10% bracket for the first time ever. 
  • Long Term Capital gains and dividend taxes were also lowered. 
  • The estate tax was lowered along with other new provisions. 

In their infinite wisdom Congress also inserted a “sunset” into this new legislation. It seems they knew that this rare spirit of co-operation would likely not last and once the economy got back on track they needed a chance to revisit these measures. Well, the sunset was scheduled to expire in 2010. However, recall the fiscal cliff debates during the summer of 2011 which caused the Government to shut down. This was simply a disagreement over an extension of the 2010 sunset. Once we got to the end of 2010 instead of a new agreement Congress simply installed a temporary extension which patched the issue for later. Congress and the White House simply could not come to an agreement on how to undo the Bush tax cuts installed after 9/11. There is little doubt that the robust growth that occurred from 2003-2008 was fanned by lower taxes. 

That is the reason I had often commented to you that “These are the lowest tax rates you have had in your working lifetime.” Unfortunately, I can no longer make that statement. As of 2013 rates have increased. We are in this era of soaring National Debt-$16 trillion and counting and large financial commitments to Social Security and Medicare that will continue to be a burden until…. In this environment tax increases are being viewed as a solution to both. 

  • The top rate has increased to 39.6%.
  • There is a new maximum long term capital gains rate of 20%. 
  • There is now a new Medicare surtax of 3.8% that applies in certain situations. 

Lastly, itemized deductions- namely home mortgage interest, real estate tax deductions and other schedule A write-offs are subject to phase out at $250,000 for singles and $300,000 for married couples. Last I checked $300,000 in income is a long way from Billionaire status.

Now, for those of us lucky enough to live here in Illinois our state income tax has increased from 3% to 5% in recent years. This increase, which was supposed to be a temporary measure to help decrease our deficit, is now rumored to become a permanent rate. I give these notes not to depress you, but to prepare you for this new tax heavy world. Looks like we need to settle in, we’ll be here for a while. I will be watching to see if these higher taxes affect how investors and companies spend, save and invest. For now, we need to make sure we do not do anything that would worsen our income tax issues. 

You’d be amazed at some of the stuff I’ve seen (another reason to have your wealthy neighbor give me a call).

For those of you who took advantage of the ROTH IRA conversions at the end of 2010 you should be pleasantly surprised. While paying taxes on the conversion may not have been pleasant they were paid at lower rates and I believe account vales have risen nicely.


Inflation, Inflation, where art Thou??

Interest rates have been artificially low going on five years now. You would expect inflation to have become an issue by now. Indeed one of the things that has surprised me is the fact that most common measures of inflation show no substantial rise at all in the prices of goods and services. 

  • Oil prices are stable 
  • Gas prices are the lowest in 2 years 
  • Copper prices, Corn prices, Coffee: They are all well contained. 

With economies around the world showing signs of sustained recoveries I am on high alert for signs of Inflation. Our investment strategies will need to change during an Inflationary environment. But so far, there is none.

What happens after two straight positive years in the stock market?

2013 marked the second consecutive year of positive stock market returns. Now that markets seem to be calmer I will be watching to see how investors react this year. There are still record amounts in cash, money markets and low yielding CD’s. Will this be the year that people tire of missing out on higher returns? Will the turtles peek from their shells? Last year was the first year of negative returns for bond investors in many, many years. Investors buy bonds for safety, for steady returns and to earn an interest rate. That didn’t happen in 2013 and the stock markets posted above average returns. Will bond, cash and Gold investors begin to invest in stocks?


The Economy is not the Stock Market

Speaking of the economy there is a subject I have been impatiently waiting to comment on. I get lots of reaction to what is currently going on in the economy as a decision making input as to whether now is a good time to invest. Here is the headline: The economy is NOT the stock market. Let me explain. The economy is vast. Here in the U.S. we have a $16 trillion economy. There are many components to our economy: Health Care, Manufacturing, Business Spending, Consumer Spending, Housing etc. This is a big slow moving mountain of a thing. Once it gets started it is hard to stop-think tanker and once it is stopped it takes lots of activity to get it going-think Space Shuttle. 

Now, on average our economy has grown at roughly a 3% rate. In some periods much slower and in some periods it has grown much faster. But, mash them all together and average them and you get 3%. Over long periods the economy and stock markets will move in the same direction, but in the short term anything can happen. Don’t believe me? Let’s take a look at Greece. We all know the tragic economic situation Europe finds itself in. There is no need in me regurgitating it. As of January 2013 Greece was entering its fourth year of recession. For the year ending 2012, the Greek economy shrank-again. Now, what do you think happened to the Greek stock market? Well, would it surprise you to learn that it was one of the best performers in the world in 2012? The Athens index returned over 30%(money12/12)

We had the same situation here in the U.S. in 2009. In March of 2009 the Dow Jones Industrials fell as low as 6,600. By the end of the year the index was at 10,428 for a total 2009 return of 18%. Mind you, we were still in recession. How can this be you ask? Well, it is really quite simple the investment markets FORECAST. It is another way of saying the markets look ahead; they anticipate where the economy is going-think windshield, not where it’s been-think rear view mirror. As further proof, last year, 2013 our economy only grew 1.4% (GDP). Yet, the S&P gained 29%. Now, with that explanation out of the way feel free to have your friends and relatives that have been sitting on their wallets waiting for the all clear to give me a call.  


I just have to say it

One of the more common discussions I have with client’s centers around this theory of how the account should be invested as people age. Here is a common discussion:

Client: Well Noland, I am 58 now shouldn’t I have most of my money in Bonds and CD’s. I am only 4 years away from my desired retirement date. Shouldn’t I be getting more conservative?

This isn’t the only version of this question. I also hear theories people have heard at dinner parties like: The percentage in bonds you should have should match your age.

The truth of the matter is there is no one size fits all strategy to answer this question. Any good Advisor will ask you to supply information about your: financial resources, the size of your portfolio, what tax bracket you are in, when you might need the money back and how risky do you want to be. Here is what I would like you to think about when considering the question of how you should be invested as you age.

 *Think about how long the money will be invested. When you retire you will NOT sell everything and take the lump-sum cash and spend it in year 1. You will spend a little every year in hopes that there will be money to last throughout your lifetime and even some leftover at your death. (Trust me, that is what your kids are hoping!). If you and your husband retire at 60 there is a good chance one of you will live to at least 90. So the money needs to last at least 30 years. A 30 year time horizon makes you a long term investor. Now let’s consider investment returns over the last 30 years (1993-2012):

Cash/Cash Alternatives (Treasury Bills): 3.0%

Bonds (Gov Bonds):    8.6%

Stocks (Large Stocks): 8.2%

Inflation:                2.4%

(source:Ibbotson 2013)

(Please consider this time period includes the market crashes of 2000-2002-bursting of the technology bubble-and the financial crisis of 2008-2009. Also consider these are the best bond market returns in history as interest rates have gone from 6.60% in 1993 to 2 % at the end of 2012.) (U.S. Dept of treasury)

The issue that concerns investors as they age is worry about a market crash which devastates their net worth when they are most vulnerable. The suggestion is that if more monies are in bonds, cash or CD’s there will be more protection from a crash. This is very understandable and makes common sense, but not financial sense. When money is held in bonds and cash we are still exposed to the ravages of inflation. Over time this has averaged 3%. So even if we earn 3% per year we are not getting ahead we are simply staying even. Take a look at your bank statement and see what interest rate you are 

receiving right now. While a market crash could do devastating psychological damage with careful planning your retirement situation should turn out fine. Although in any one year period shares could decline, since 1926 there has never been a 20 year timeframe that stocks haven’t shown positive returns.

Over the last 5 years Investors who have hibernated and kept their monies un-invested have experienced the worst of all outcomes. They lost money during the market downturn and then failed to put the money back to work so they have missed on out on the recovery. If you had fallen into a coma in the summer of 2008, before the stock market downturn, and woke up on New Year’s Eve 2013 you would have wondered what all the fuss was about. The market was about 12,000 on the Dow when you turned into Rip Van Winkle and was about 16,000 when you woke. Again, the longer the timeframe you have to invest the less risky investments become. (With that being said please remember that investing involves risk including the possible loss of principal and that while stocks can offer long-term growth potential they may fluctuate more and provide less current income than other investments. An investment in the stock market should be made with an understanding of the risks associated with common stocks, including market fluctuations).

Did you Know????

When accessing the investment climate I have always been a proponent of taking account of the following 4 very important factors. 

1.) Interest Rates-It is a fact that when rates are low this has a positive impact on the investment climate. Companies are able to borrow more cheaply; homeowners are able to lower their mortgage payments etc. This level of interest rates is important, but what’s more important is their direction. We should always consider: Where are rates headed?? 

2.) Inflation-When inflation is moderate and steady the investment climate is more attractive than when inflation is soaring, like in the late 70’s. Soaring inflation is not a great environment for investment returns, especially for fixed return holdings like bonds and Real Estate. At the present time Inflation seems to be subdued. 

3.) Earnings-If corporate earnings are improving that is a good thing. One of the factors that drove stock prices so low at the end of 2008 and early 2009 was that corporations were earning much less profit and cut payrolls and expenses which caused the economy to shrink. The opposite is true when earnings are growing. I am looking for 2014 to end with companies earning more money than they did in 2013. I get the feeling that companies will start feeling the pressure to play offense again.

4.) Valuations-All else being equal you’d love to buy things when they are cheap which is preferable to buying that same thing when it is expensive. Now imagine a suit you’ve been eyeing at Nordstrom. You go in the store in October and the suit is $500 so you decide to pass. You are back in Nordstrom during their after Christmas sale and see that same suit and it is now $300. You are much more likely to buy the suit at $300. In the Investment markets we can apply that same logic and surmise that PRICES MATTER. Over time we get much higher returns when we buy investments at a low price opposed to paying a very high price. In 1999, before the technology bubble popped prices were very high. Indeed P/E ratios on the S&P were over 25. The returns over the next 10 years were uninspiring, to say the least. Compare that with prices in 2009 after the recent financial crisis. Prices were very cheap. Again, returns since then have been well above average. The price we pay for our investments do matter. Unfortunately, in the investment world we either get cheap prices or good news-But not both!!! I am glad to report that as of today-Early 2014 prices are still pretty good. In my opinion we have the opportunity for very attractive returns over the next few years because prices are still attractive. Not dollar store cheap, but still not very expensive. 


As we kick-off 2014 I like where we stand. Interest rates are heading upward, but only modestly. The Fed has promised to keep short term rates low until 2015. Long term rates, as measured by the 10 year Treasury bond have increased, but are still below 3% which shouldn’t provide a huge headwind to the investment markets. Inflation is nowhere to be found at this moment. The markets aren’t expecting much growth from corporate earnings, but we’ll need to see some progress. I expect that companies that deliver growth to be rewarded and those that don’t to be left behind. It’s another way of saying that I expect 2014 to be a year where the stock market acts like a Market of Stocks. Stocks are not as cheap as they were. But, prices are still not very expensive. As I write the S&P sports a P/E of 15.4.

The most common question I have been getting these last few months has to do with markets relentless rise. It seems to have come out of nowhere and investors are incredulous. I keep getting asked about a correction. I guess if this is everyone’s biggest worry that ain’t so bad… Here’s the big deal; Corrections happen. They have always happened and they will always happen. At any given time markets can decline. A decline of 2%, 5%, 9%, 12% or even 15% is actually pretty normal. The intimation in the question is; should we do something? I have always said “we don’t run from corrections, we only run from a collapse.” Think of it this way: Imagine you are at O’Hare airport on your way to always sunny Hawaii. Once you board the pilot comes on the overhead and announces “We are expecting some turbulence during the flight, but we should still have you there on time.” Now, once the plane starts shaking you simply grit your teeth, order a cocktail, buckle up and wait. During market corrections we can do the same thing. I will always be reviewing the available investment options to determine the most attractive and appropriate holdings given the current environment. However, what has worked best in the past is simply to buckle up and wait. 

As always, I will be watching and continuing to work hard for you and looking for opportunities to profit this year and in the years ahead!!!!