2013 proved to again be very friendly to investors. In fact, it marked the second straight year – after 33 straight years to the contrary – that the S&P 500 never had a negative year–to–date performance. Notwithstanding that fact and the over 32% return of the S&P 500, we believe 2013 will be remembered as the watershed year that pushed the world from a recovery mindset towards a normalized mindset, forcing investors to reset their investment framework for the next phase of investing when we expect that fundamentals will be far more important than Federal Reserve policy. Clearly the Fed has finally begun to shift its stance towards a more normalized framework with the initial taper in December and subsequent taper in late January.
While one can debate the effectiveness of the multiple rounds of quantitative easing and the ultimate “price” to be paid down the road, one must now consider that the Fed has orchestrated a relatively successful path towards the restoration and normalization of “animal spirits.” This past year has significantly restored business confidence – Moody’s recently released data that business confidence is at its all-time high.
While it is certainly good news for the world to finally normalize and get off of the Fed morphine drip, there is another side to the story – normalization may not be all positive for the equity market. As investors adjust their framework away from artificial Fed support to corporate fundamentals, we expect a return to normalized volatility, where equity prices, as the old saying goes, may “go down as well as up.” In fact, there could be significant fundamental head winds facing equity markets in 2014.
Having said this, we must acknowledge the significance of the Fed chair and execute our investment strategy with Fed policy in mind. We expect monetary policy to continue to be highly accommodative, but with less attention paid to markets and investor psychology. As a result, Fed policy could overshoot and create higher-than-desired inflation. In the meantime, we focus our time on investments that are attractive on fundamental merits while also developing and implementing portfolio strategies that should prove resilient and be well-positioned when markets inevitably pullback.
More than at any time over the past four years, we believe an investor’s “toolkit” should not be limited to equities and core bonds. Stocks have limited room to run, and the bull market in bonds is clearly at an end. Alternative assets, if implemented in a portfolio properly, have the ability to drive significant outperformance in this environment.