I think we can all agree that 2014 has gotten off to a pretty
inauspicious start in the stock market.
After a fairly flat open through the first half of January, the stocks
have dropped almost every day since mid-January. The Dow Jones Industrial Average has shed
over a thousand points in roughly two and a half weeks, often by triple-digit daily
declines. On a percentage basis, a
thousand points isn’t what it used to be, but it’s still hard to watch.
The decline has been partially driven by currency volatility
in certain global markets, but the real underpinnings of the selloff in the
U.S. have been a mediocre fourth quarter earnings season.
In our most recent market commentary, we noted that stock
valuations have become relatively high by historical standards and we felt that
the forthcoming earnings announcements would be weak. This now seems to be the case. We further noted that based on these factors;
there wasn’t a good case for continued strong stock performance this year. What is currently unfolding is consistent
with that hypothesis.
The Dow Jones Industrial Average has had a rougher start to
the year than the S&P 500, declining 7.26% vs. 5.75%. These percentages are still not large enough
to qualify as a market “correction” (defined as a 10% decline), but they’re not
that far off and will likely get there in our opinion. So if we saw this coming
why, not sell and lock in our profits?
The simple answer is that we feel that this is a short-term situation
and still believe we’ll end the year modestly higher. In the meantime, there isn’t a good
investment alternative.
If interest rates drift higher this year, as we expect,
anything but the shortest maturity bonds will see declines in their
values. The yields on very short-term
bonds are barely 1%, which means in real terms, you’re losing money. Conversely, our equity cash flows are still
in the 2% range. Thus, we’re getting
better income by remaining invested and riding this stock market volatility
out.
The month of December has always had the largest dividend
payouts of the year. Thus, we’ve
recently accumulated larger than normal cash reserves in most of our client
portfolios. We aren’t necessarily
viewing this as a great buying opportunity, but are taking this selloff as a
chance to put some of our cash back into the market. If stocks do finish 2014 at least flat, the
returns on our most recent equity purchases should return north of 9% for the
year. Until then, don’t be surprised to
see the Dow drop below 15,000.
