January Effect

As you can see from the chart above, the major stock market indices enjoyed a great month and an impressive trailing twelve month total return. In the face of the fiscal cliff hype and all the negative headlines, how did we get here? At the end of the day stock prices are driven by fundamentals and valuations. The higher equity prices reflect strong corporate earnings, a more confident consumer, a slowly improving housing market, a strong energy sector in the U.S., and low interest rates. Our 2013 stock market outlook, based on current valuations, was for high single digit returns. Even though we are halfway to that level after only one month, we are still constructive on equities. Our forecast was based on S&P 500 earnings for 2013 of $111.00 and a return to historical price earnings ratios of 14.3 times. The market still has another five percent of upside until it reaches what we believe to be a conservative fair valuation. From there, the questions are; will the market move to an overvalued state (which it usually does) or do earning continue to grow to keep the market at a conservative fair value? Either way, there are still growth opportunities in equities.

We have been warning investors to lower their expectations from the bond market for a year now. The warning light is now flashing as the Barclays Aggregate Index fell 0.70% in January. If you owned the fixed income asset class over the past 3,5,10 or 15 year periods your annual returns should have been in the 5%-6% range. Mathematically, these results cannot continue forever. The current reality is the 10-year U.S. Treasury Note yields 2.00% and credit spreads are at historically tight levels. Price appreciation in bonds can come from either interest rates moving lower or credit spreads tightening. At these levels one cannot bank on price appreciation in bonds. The other component of return in bonds is yield. We know yields range from zero to 4%. With this backdrop, expect the bond portion of your portfolio to return 1-3% this year. If you “earn the coupon” it will be a good year.

There are still eleven months left in this year and many more months left in your long-term financial plan so it is not too late to properly position your portfolio. Talk to your advisor and make sure your portfolio is in line with your investment objectives.

Posted on February 1, 2013
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