As we look back at 2013, we will remember an economy and labor market extending lackluster trends of the previous four years: the gross domestic product continued to lurch forward, inflation rates remained anemic and private sector employment experienced 12 months of positive job growth.
In addition, modest macro improvements came in the face of political grandstanding, a governmental threat of debt default and obstructive fiscal drag.
However, stock markets, buoyed by historically loose, unconventional monetary policy entailing record bond-buying by the Federal Reserve, generated record highs while extending one of history’s longest bull markets.
What outcomes witnessed in 2013 can help us understand economic trends in 2014? The answer may lie in the stock market.
If history is any indication of future performance, then 2014 should be a favorable year for stocks. According to a Charles Schwab investment report, this was the 18th year the SP500 eclipsed 25 percent in annual returns; the subsequent year’s returns have averaged six percent.
The Dow Jones Industrial Average, the other most commonly tracked stock market index, has experienced 30 years of returns greater than 25 percent. Of the 30 years, 23 were followed with positive returns.
The widely-tracked Standard and Poor’s 500 Composite Index experienced a 30 percent return during 2013, the highest annual return since 1997 and the tenth highest annual return over the last century.
The 12-month gains extended the sixth longest bull market in SP500 history at 4.8 years and counting. Additionally, according to data compiled by Bloomberg LP, 2013 marks the first time all nine of the market segmented Russell indices gained more than 30 percent each.
Some observers have identified the record high nominal price level and bull market duration as evidence of elevated risk and impetus for market correction downwards.
However, stock market valuation levels are consistent with a “reasonably” priced market. For example, the price-to-earnings ratio, which measures how much an investor is willing to pay for one dollar of earnings, currently hovers around 16, roughly equivalent to the historic average.
What’s more, SP500 prices, after accounting for inflation, are still 7.5 percent below the high, in real terms, attained in August 2000.
2013 was also accompanied by a slowdown in bond, gold and emerging market growth. All three sectors generated a negative return year-over-year. In fact, the bond market had its worst performance in 14 years, generating losses for only the third time in 28 years as indicated in the investment report.
The first trading days of 2014 have been quite volatile, with little indication of price trajectory for the remaining days of January. Researchers have found smatterings of evidence that returns in January have outperformed those in the other 11 months.
This market anomaly, known as the January effect, takes root in the observed increases in trading volume resulting from drops in December prices as investors sell stocks that lost over the year to offset capital gains.
Most economists view such anomalies as transient, and tax sheltered retirement accounts exist minimizing the attractiveness of late-year tax-driven portfolio adjustments. January performance has served somewhat as a bellwether for market performance over the year’s remaining months.
Of the 25 times since 1975 that the SP500 return in January was positive, 23 times, or 92 percent, subsequent annual returns were also positive. Of the 14 times January returns were negative, over the same period, markets experienced annualized losses six times. Year-to-date the January return for the SP500 has been positive, up 0.6 percent.
Stock-market gains in 2013 were infused by both Central Bank policy and by investor and institutional trends. The Federal Reserve maintained vast purchases of longer-term securities and continued to inject large amounts of liquidity into commercial bank reserve accounts driving short and longer-term interest rates down and making the investment into bonds relatively less attractive compared to that of stocks.
The domestic stock market appears primed for another year of positive returns, but only time will tell what 2014 has in store. The outcome may well hinge on how soon — and to what extent — the Federal Reserve removes the punch bowl of loose monetary policy from the party.
Dr. Nicholas J. Mangee is an assistant professor of economics at Armstrong Atlantic State University and can be reached at Nicholas.mangee@armstrong.edu.