4Q14 Market Overview
The last 12 months have shown the value of being a long-term diversified investor. As we started 2014, return expectations were low as volatility regained the spotlight. A long list of concerns clouded the judgment of many cautious market forecasters given their softer company profit margin expectations and higher interest rate predictions.
In the end, accommodative global monetary policies prevailed and drove U.S. equity markets to new records. Unlike the U.S markets, international equities struggled under the weight of a stronger U.S. dollar. Fixed income investors were rewarded by staying the course and ignoring the headline news to reduce bond exposure.
Looking forward, we are encouraged by an improving U.S. economy and the Federal Reserve’s general direction. So far, they have been successful in removing stimulus and will now carefully consider the need to raise interest rates. However, we will continue to take advantage of diverging market trends by rebalancing to target allocations to maintain your desired risk level. This process typically involves harvesting gains in the most tax-efficient manner possible and re-allocating the proceeds to out of favor asset classes, such as, international equities.
U.S. Equity Markets
The U.S. equity markets surged ahead the final few weeks of the year to close out a positive quarter; the Russell 3000 return was up 5.2% for the quarter and an impressive 12.6% for the year. Favorable and improving economic data helped elevate the markets to new records during the quarter. In year-end reports, the Commerce Department reported an unexpected healthy revision in third-quarter U.S. gross domestic product (GDP). According to the report, the U.S. economy grew at an annualized pace of 5% from July to September (up from a previous 3.9% estimate) and marked the fastest clip in over 10 years. This positive revision was the direct result of an uptick in business investment and consumer spending. Consumers are feeling the benefits of the precipitous decline in fuel prices which should also slightly improve overall GDP growth.
International Equity Markets
International developed equity markets struggled with a loss of 3.6% for the quarter and disappointing annual loss of 4.9% for the MSCI EAFE. The U.S. dollar gained additional ground against most major currencies to close out the year which inflicted further damage to dollar-based investors. After experiencing more disappointing euro zone manufacturing data and anemic inflation, the European Central Bank (ECB), will likely resort to bolder quantitative easing actions. The ECB’s stimulation program could include government bond buying which helped speed up the U.S. and U.K. recoveries. In Japan, the “Abenomics” ambitious turnaround plan stalled a bit as Japan’s GDP shrank in the second and third quarters of 2014. This downturn resulted from April’s consumption tax hike which was enacted by the previous government and the impact should fade as their economy moves toward full capacity. China surprised the markets by reducing interest rates for the first time in two years. This interest rate cut should help lessen the sting of a slowing economy as the government tries to stimulate internal growth. Although China was a bright spot in emerging markets, the MSCI EM was down 2.2% for the full year. After two consecutive years of underperformance relative to the U.S. markets, both developed and undeveloped international markets look more attractive for long-term investors who can take advantage of the dollar strength to buy in at lower prices.
Safety-minded investors gained ground during the quarter; the Barclays Aggregate was up 1.8% for the quarter and 5.9% for the full year. Against consensus estimates, the 10-year Treasury yield declined from 3.04% on January 1 to 2.17% on the final trading day of the year and helped the broad market post its best annual performance in over three years. Given the 87 basis point overall yield reduction, we would expect investors with the longest dated maturities to benefit the most since their existing bonds are more valuable compared to newly issued securities. This is exactly how the markets priced in this new reality, by rewarding the Barclays US Government Long with a 24.7% annual gain, Intermediate with a 2.5% gain and Short with a slight gain of 0.64%. In the international fixed-income arena, the JPM Non-US Unhedged posted a 2.5% annual loss under the weight of a robust US dollar. The Barclays Municipal continued to reward tax sensitive investors trying to lessen the drag of new investment related taxes, gaining 9.1% during the year.