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Enjoy the Market Rally, But Prepare for the Retreat!

Investors may be lulled into a false sense of security by this market.

Will the current bull market run for another year? How about another two or three years? Some investors will confidently say “yes” to both questions. Optimism abounds on Wall Street: the major indices climb more than they retreat, and they have attained new peaks. On average, the S&P 500 has gained nearly 15% a year for the past eight years.

Stocks will correct at some point. A bear market could even emerge. Is your investment portfolio ready for either kind of event?

It may not be. Your portfolio could be over weighed in stocks and stock mutual funds – that is, a higher percentage of your invested assets may be held in equities than what your investment strategy outlines. As your stock market exposure grows greater and greater, the less diversified your bull market and bear marketportfolio becomes, and the more stock market risk you assume.

You know diversification is important, especially when one investment sector that has done well for you suddenly turns sideways or plummets. When a bull market becomes as celebratory as this one, that lesson risks being lost.

How do bear markets begin?

They seldom arrive abruptly, but some telltale signs may hint that one is ahead. Notable declines or disappointments in corporate profits and quickly rising interest rates are but two potential indicators. If the pace of raising rates speeds up at the Federal Reserve, borrowing costs will climb not only for households, but also for big businesses. A pervasive bullishness – irrational exuberance, by some definitions – that helps to send the CBOE VIX down to unusual lows and can be seen as another indicator of a bear market or stock correction.

How long could the next bear market last?

It is impossible to say, but we do know that the longest bear market on record lasted 929 days (calendar days, not trading days). That was the 2000-02 bear. A typical bear market lasts 9-14 months.

Enjoy this record-setting Wall Street run, but be pragmatic.

Equities do have bad years, and bears do come out of hibernation from time to time. Patience and adequate diversification may make a downturn more tolerable for you. You certainly do not want the value of your portfolio to fall drastically in the years preceding your retirement.  If this happens, you will have a narrow window of time to try and recoup that loss. Remember, the market does not always advance. It may be time to lock in these gains or re balance your portfolio.

Be careful listening to the media.

So while 15% gains sound great, way over 200% gains without a significant correction; the average annual return since the 2000 bear market has been only 4.11% (without dividends). Adjust for inflation and the return goes down to 1.90%. Minus out taxes, management fees, brokers fees and expenses and it seems like those that have been in the market since 2000 are still losing money.

The coming correction is right around the corner. Be Proactive, Not Reactive. Our clients didn’t lose a dime in 2000 or 2008. How low can it go? That’s anyone’s guess but this guy thinks it will be the Worst Stock Market Crash Ever… and that would be pretty bad.

Economy, Fed

New Chair, Same Fed?

In more than three hours of testimony before the House Financial Services Committee on February 11, new Federal Reserve Chair Janet L. Yellen laid out a monetary policy blueprint very similar to that of her predecessor, Ben Bernanke.1 Even so, Yellen — the first woman to head the central bank — takes over at a turning point when the Fed has begun to wind down the extraordinary measures instituted during the recession and may need to shift course as the economy continues to recover. This might be a good time to consider the direction the central bank is likely to take under its new leader.

Meet the Chair
Dr. Yellen — who prefers to be called “the chair” rather than chairwoman or chairperson — is a highly regarded economist who has specialized in the causes, implications, and mechanisms of unemployment. She received her Ph.D. in Economics from Yale and taught at Harvard and the University of California at Berkeley, where she remains on the faculty as Professor Emeritus. Yellen joined the Federal Reserve Board of Governors in 1993 but left in 1997 to chair the President’s Council of Economic Advisers through 1999. She returned in 2004 as head of the Federal Reserve Bank of San Francisco before becoming Vice Chair of the Board of Governors in 2010.2

Yellen has a reputation as a clear communicator who can present complex economic issues in plain language. She is considered a “dove” who is inclined to allow a freer flow of funds to stimulate jobs and wages in carrying out the Fed’s dual mandate to foster maximum employment while controlling inflation.3 (By contrast, “hawks” tend to be more concerned about the potential for inflation.)


Forward Guidance
Under Ben Bernanke, the Federal Open Market Committee — charged with setting monetary policy — began issuing “forward guidance” to provide advance notice to consumers, businesses, and investors regarding future policy direction. In December 2012, with the unemployment rate at 7.8%, the Committee anticipated maintaining a near-zero federal funds rate — its primary tool to stimulate the economy — as long as the unemployment rate remained above 6.5% and inflation expectations were no more than half a percent above the longer-run goal of 2%.4–5

A year later, in December 2013, the unemployment rate had dropped to 7.0% and was on its way to 6.7% by the end of the month.6 Recognizing that unemployment was only one part of the labor picture, the Committee hedged on its previous statement, indicating that it would consider a wider variety of economic factors and expected to maintain the low federal funds rate well past the time that unemployment declines below 6.5%, as long as inflation remains in check.7 This has created an open-ended situation in which Yellen and her colleagues must decide which conditions might trigger raising rates.

Yellen’s Perspective
With unemployment down to 6.6%, Yellen affirmed this policy shift in her testimony to Congress, citing other labor concerns such as the large numbers of long-term unemployed and the underemployed, and the fact that wages have lagged growth in productivity. In addition, she emphasized that inflation has remained low and is not an impediment to maintaining the near-zero federal funds rate for now.8-9

At the same time, Yellen stated her commitment to the current gradual pace of tapering the Fed’s bond-buying program (known as “quantitative easing”) — which has put downward pressure on longer-term rates — unless there is a “notable change in the outlook.” She also emphasized her commitment to the Fed’s mission as a regulatory authority over the financial industry.10

What Can You Expect?
Yellen’s message offered a welcome shot of confidence for the stock market, which values consistency and seems reconciled to gradual tapering in an improving economy.11 Her stance might also inspire confidence among businesses and consumers who may benefit from low interest rates for expansion, hiring, and purchases.

For retirees and others who might prefer higher rates on savings, however, the prospect of prolonging the low-rate environment could be a concern. Consumers who see prices rising at their local grocery stores may wonder about the talk of “low inflation.” However, aided by lower gas prices, inflation (based on the Fed’s preferred measure) was only 1.1% in 2013.12

It appears for now that the Fed will take a measured approach under Janet Yellen, emphasizing job creation as a stronger policy focus than controlling inflation. However, Yellen also made it clear that the central bank would react as necessary to significant changes in the economy.13

All investments are subject to market fluctuation, risk, and loss of principal. Investments, when sold, may be worth more or less than their original cost. For more information on this topic please contact Ben Borden Richmond, Va Financial Advisor, (804) 282-8820

1, 3, 9–10, 13), February 11, 2014
 2, 4, 7) Federal Reserve, 2013–2014
 5, 6, 8) U.S. Bureau of Labor Statistics, 2014
 11) Bloomberg, February 11, 2014
 12) U.S. Bureau of Economic Analysis, 2014

Economic Outlook For 2014

What Can We Expect in 2014?

The beginning of the year is a traditional time to look forward to potential economic developments. Although forecasts can change due to unforeseen circumstances, the economic outlook for 2014 is generally positive, with a return to solid growth and the possibility of even stronger economic performance, depending on several key factors that should become clearer over the next few months.

GDP, Unemployment, and Inflation

As of late December 2013, year-over-year growth of real gross domestic product (GDP) was expected to range from 1.7% to 2.3%, higher than was expected earlier in the year but lower than the 2.8% rate in 2012. The economy is projected to bounce back in 2014, with growth of around 2.7% to 3.2%, near the 50-year average of 3.06%.1–3 Unemployment, a drag on the economy throughout the recovery, has begun to show improvement, dropping to a five-year low of 7.0% in November 2013.4 This trend is expected to continue, with unemployment averaging 6.3% to 6.7% in 2014 before dropping further in 2015 and 2016.5–6 More Americans with jobs could stimulate consumer spending, which represents almost 70% of GDP.7 Annual inflation was projected to be a relatively low 1.1% to 1.2% in 2013. The Federal Reserve expects the rate to rise slightly to around 1.4% to 1.6% in 2014, still short of the Fed’s 2% target rate for optimal growth.8 Although consumers may prefer no inflation at all, a moderate increase may bode well for the economy.

Economic Outlook 2014 - Stock Market

Federal Government Issues

The federal government caused some short-term economic damage in 2013 by raising taxes in January, allowing across-the-board sequestration cuts in March, and shutting down the government in October.9 Although the economy seems to have weathered the tax increases and budget cuts, the shutdown may have reduced fourth-quarter GDP growth by as much as 0.6%.10 The good news for 2014 is that the bipartisan budget bill (passed on December 18) replaces some sequestration cuts with more targeted reductions, and approves spending limits for 2014 and 2015, thereby reducing the likelihood of another shutdown.11 A battle over the debt ceiling could still develop in February, but if that can be resolved without further damage, a more functional federal government may help stimulate economic growth.12

Tapering Time

To stimulate the economy, the Federal Reserve has held short-term interest rates near zero for the last five years and increased the monetary supply through bond-buying programs called quantitative easing (QE). In a December 18 announcement, the Fed clarified its intention to maintain low short-term rates for the foreseeable future while beginning to taper its QE program in January 2014, reducing bond buying from $85 billion per month to $75 billion. This was only a first step, but the Fed indicated that further tapering should be expected if the economy continues to improve.13 Tapering had been widely anticipated by nervous investors, who feared negative consequences if the Fed turned off the financial faucet.14 However, the incremental approach — combined with clear communication and the assurance of low short-term rates — sent the stock market to new highs.15 Some analysts believe that ending the stimulus may be good for the market in the long term by reducing dependence on easy money and allowing share values to settle at more realistic levels.16 Initial response from the bond market was muted, with a slight drop in prices and a corresponding increase in yields. However, continued tapering could lead to higher long-term interest rates. This might benefit investors (including retirees) looking for returns on fixed-income assets, but it may increase interest rates on credit cards, auto loans, mortgages, and private student loans.17

Potential Business Expansion

A key issue for 2014 is whether U.S. businesses will increase investment. Corporate after-tax profits for the third quarter of 2013 rose to a record 11.1% of GDP, almost double the 6.1% average since 1929. However, businesses have been slow to expand due to reduced consumer demand and an uncertain economy. The improved unemployment picture suggests this may be changing. In a stronger economy, corporations may have to invest or lose market share. If corporate America does loosen the purse strings, more jobs could be created that will drive economic growth.18 Although it’s important to keep an eye on economic news, your investment strategy should be based on your overall objectives, time frame, and risk tolerance.

The principal value of all investments may fluctuate with market conditions. Stocks, when sold, and bonds redeemed prior to maturity may be worth more or less than their original cost. Investments seeking to achieve higher yields also involve a higher degree of risk.
1, 5, 8, 13) Federal Reserve, 2013
 2, 6, 9, 12) University of Michigan, 2013
 3, 7) U.S. Bureau of Economic Analysis, 2013
 4) U.S. Bureau of Labor Statistics, 2013
 10) Standard & Poor’s, October 16, 2013
 11), December 18, 2013
 14, 16) CNNMoney, December 17, 2013
 15), December 18, 2013
 17) MarketWatch, December 18, 2013
 18) The Wall Street Journal, December 15, 2013
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