The stock market had a good year in 2013 and consensus expectations among Wall Street strategists is for a positive 2014. Below is a summary of the consensus view:

· The U.S. and global economies will continue to improve

· Stocks will move higher as earnings growth accelerates

· Interest rates will move higher (bond prices lower) as the Fed tapers

· Gold prices will continue to fall

As often happens in the investment markets the exact opposite has occurred so far this year. Stocks are down, interest rates are lower and gold is up. So what’s going on? Why is the market moving against all the experts and what is causing all this nervousness in the first few weeks of 2014? I’ll highlight a few reasons why I think the market is down in January:

· Softer economic data (weak PMI/manufacturing) emerged from China. China is the largest of all emerging market countries and is watched closely by investors

· New concerns over China’s banking system

· Political turmoil in Turkey, Argentina, South Africa and the Ukraine

· Emerging market currencies have been in free-fall (higher interest rates/stronger dollar in the U.S. to blame)

· Concern over the impact of Fed tapering back QE bond purchases (currently at $75 billion per month, but expected to be lower as the year progresses)

Mounting concern about the emerging markets and Fed tapering has sparked a “risk off” trade in January. This is where investors shift money from riskier assets such as emerging markets, U.S. stocks and commodities to safer assets like U.S. Treasury bonds and gold. The emerging market/Fed tapering concerns are interconnected. The thesis works like this;

Fed tapering will raise U.S. interest rates, which will strengthen the U.S. dollar, which makes emerging market exports more expensive, which hurts emerging market currencies, which hurts emerging economies, which slows global growth, which hurts U.S. stocks. Simple….right?

There is also the “January Barometer” to consider. This is the belief that as the month of January goes, so goes the rest of the calendar year. The theory is that a bullish beginning to the year boosts investor confidence which bodes well for the entire year and vice versa. If this stock market barometer is indeed an accurate predictor of the rest of the year, then we could be in trouble. In reality the usefulness of January as a return predictor is dubious at best. The chart below shows that January and annual returns have a .30 correlation (not very good). In fact April, May, September, November and December all have higher predictive power than January.

Recent concerns over the emerging markets and Fed tapering have cooled the bullish sentiment investors had going into the year. So far stocks are down over 3%, interest rates have gone from 3.00% to 2.75% and gold is up $50. This is making longer term investors nervous, but let’s keeps in mind:

· One month of soft data from China doesn’t imply a hard landing in the emerging markets

· Fed tapering is a good thing if a strong economy supports it

· A small correction after a strong year should be expected

At Gradient we constantly monitor the health of the emerging markets and Fed policy. The U.S. companies we invest in sell a lot of goods and services into these economies. Today we are in a global marketplace more than ever and we must be aware of the environment. Even though prices are down, market fundamentals are still intact. The U.S. economy strengthened in the back half of 2013 and corporate earnings are still good. The general tone of earnings has been good and the following companies reported nice earnings for the 4th Q of 2013:

Honeywell, Microsoft, Starbucks, Kimberly Clark, Verizon Bank of America, Lockheed Martin, Caterpillar and Netflix

The following weren’t so good;

Intel, Johnson & Johnson, Apple and Coach

We’ll continue to analyze corporate earnings along with the economy; we remain constructive on the markets and believe investors with a sound allocation that fits their investment objectives will be fine. Investors seem to have forgotten that stocks don’t go up every month, and January could be one of those months. There are always concerns in the global investment markets (remember last year’s fiscal cliff, budget sequester and debt ceiling debates), but we’re confident the long term rewards investing provides are still intact.

Year-to Date as of January 27th, 2014:

Dow Jones US Moderately Conservative Index is down 0.65% (TR) for the year

S&P 500 closed at 1,781.56 down 3.61% for the year

U.S. 10 year Treasury Futures are yielding 2.77% down 0.20% for the year

WTI Crude Oil futures closed at $95.63 down $3.07 for the year

Gold closed at $1,255 per ounce up $51 for the year

Twenty thirteen is in the rear view mirror and it is amazing how clear the picture. Last year, can you recall any market expert projecting a thirty percent return in the S&P 500? I don’t.

The S&P 500 gained 32.39 percent last year and the NASDAQ was up a mind boggling 40.12 percent. Bonds as measured by the Barclay’s Aggregate Bond Index posted its first negative return year since 1998, losing -2.02 percent. Commodities in general and gold in particular were crushed in 2013 as 27.79 percent of gold’s value melted away. International stocks continued to lag their U.S. counterparts but still gained 22.78 percent. Emerging market stocks are saving their best for another year after losing -2.60 percent.

Much more important than one year of performance numbers – what is your mindset heading into a new calendar year? This may be a good time to reflect and assess your investment attitude from one year ago and compare it to today. Twelve months ago, many investors were frustrated with the political climate in the U.S. and fearful of the looming “fiscal cliff” and its implications for the financial markets. Hopefully your emotions combined with the sensationalized headlines of the day did not derail your investment program. If it did, let experience be your teacher as we begin a new year.

The New Year brings both uncertainty and opportunity. There will not be a shortfall of market opinions. Some will be projecting the much awaited market correction, others will be riding the bull train, and the majority will likely be calling for a return to normal in the stock market with 2014 returns in the single digits. It would be easy if we knew next year’s outcome, but we don’t and we never will. Realize these are just opinions. Some will be right, many will be wrong and the markets will move through time surprising the majority.

Before you get swept up in all the hype surrounding 2014, take a moment to tune out the media noise and focus on those things under your control. If your goal is to build wealth or maintain wealth there are five controllable factors to contemplate.

First, evaluate both your saving and spending habits and determine if these are in sync with your lifestyle. How much one saves is a key component in building or maintaining the nest egg. Understanding your time horizon and making the proper asset allocation are paramount. Controlling investment expenses and properly managing the tax burden are somewhat controllable and will impact wealth creation. Keep your focus on the controllable and free yourself of the one thing you cannot control – the annual return on those assets. Instinctively we are drawn to what the market did yesterday or speculate on what it is going to do tomorrow. Focus on the factors you control and eliminate any knee jerk emotional reactions to market movements.

Is the Federal Reserve driving the bus or just along for the ride? The stock market rally is the result of both an accommodative Federal Reserve and improving market fundamentals. The Fed is working the bus’s accelerator pedal while the market has control of the wheel. Easy monetary policies delivered through a variety of Fed programs under the banners of Quantitative Easing (QE) and Operation Twist (OT) has definitely bolstered stock prices. Look at a graph of the expansion of the Federal Reserve balance sheet and the price movement of the S & P 500.

One can easily conclude Federal Reserve policy is having a positive impact on the equity market. This conclusion is further supported if you notice that the mini price corrections during this bull market occurred during short breaks in the Fed’s monetary expansion. While the Fed has given the market a supportive tailwind, the market is also recognizing better fundamentals. Corporate earnings are strong and continue to get stronger. Corporations are lean, employees more productive and profits are at record levels. The U.S. consumer has deleveraged, become more confident, and is spending once again. Housing is still well below pre-recession levels, but the current trend is positive. While the bearish investor will point to the chart above and claim this rally is just smoke and mirrors, the bullish investor will look at the chart below and tell you stock prices are driven by fundamentals such as the earnings per share of the S&P 500.

As this bull market approaches its fifth anniversary the debate continues; is this a Fed induced asset bubble or is an improving economy driving prices higher?

Our view is the Federal Reserve has created an environment for corporations to maximize their success, but ultimately it is the success of the companies themselves that will dictate the future direction of stock prices. We firmly believe the stock market is the best wealth creation machine ever invented, but it takes time and patience to generate wealth. It’s never a straight line and hurdles are already in place for 2014: government shutdown round two, debt ceiling debate, Fed tapering decisions, mid-term elections, geo-political events, and the future of Obamacare to name a few.

Regardless of the cause, stocks continued to run higher in November. The S&P 500 set new record highs twelve times and the NASDAQ reached the 4,000 level for the first time since 2000. November’s performance numbers were a microcosm of the trailing twelve months. U.S. Stocks lead the way, international stocks underperformed, investment grade bonds and municipal bonds posted small losses, high yield bonds were up and commodities declined yet again. For the month, the S&P 500 gained 3.05%, , NASDAQ Composite 3.79% and the MSCI Europe, Asia, Far East (EAFE) 0.43% MSCI Emerging Markets -1.46%.

Bonds gave back some of their October gains. The Barclay’s US Aggregate Bond Index returned -0.37% for the month and -1.61% for the trailing twelve months. Once again, high yield was the best monthly performing bond sector with a 0.51% return. Commodities continued their struggle as the Dow Jones Commodity index fell 0.80% during November.