A Rough Start

By:  Charles Webb

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.