JOSEPH W. BRUZZESI
Equity investors had a great year during 2013 as the S&P 500 index returned 32.4 percent versus a historical average of nine percent.
Cyclical plays outperformed defensive sectors as investors looked to add additional return in the wake of low interest rates in fixed-income markets.
The NASDAQ was up 40.1 percent, led by increased investment in riskier stocks and expanding price-to-earnings ratios of technology companies.
Strategists are watching equity allocation across asset classes for signals of investors moving to less risky classes such as utilities.
The retail sector has sold off as capital has been moving away from companies like Wal-Mart in fear that a reduction in nutrition assistance for low-income individuals will cut into revenues and margins.
The majority of bond indexes were plagued by losses on the longer end of the yield curve as the 10-year treasury rate reached three percent last week. Bonds on the shorter end of the curve were able to book gains as the Federal Reserve plans to continue to keep short-term borrowing costs low.
While many are focusing on the reduction in quantitative easing for changes in rates, the short-term interest rate is more influenced by the Federal Funds rate. This rate is the rate at which banks borrow money from each other overnight.
If the Fed wants to increase the short-term borrowing costs or tighten credit markets, it will raise the rate that currently stands at 25 basis points.
Consensus gross domestic product estimates for the U.S. are three percent. Combined with rising interest rates and healthier corporate balance sheets, investors are moving money back into U.S. markets from emerging economies.
Another postive sign for the U.S. economy is increased faith in financial institutions. This has been highlighted by the spread on financial debt instruments tightening by 33 basis points this year. This tightening was greater than that of materials and utilities, which tightened narrowly.
The confidence in banks is largely led by the fact that balance sheets have improved with the Fed purchasing toxic assets from investment banks and commercial banks.
The recovery was also driven by consistently improving economic data out of the U.S. For the first time in several unemployment reports, labor force participation increased. Some economists wonder if the increase was caused by more elderly workers searching for work, as retirement has become more difficult in the current economy.
However, not all is well around the world. Emerging economies are facing difficult times and there is a major threat on global growth.
As a result of damaged markets in the U.S. and low interest rates in the post-recession era, investors were willing to take on riskier equity and debt investments in the search for yield.
Increased demand for foreign assets pushed borrowing costs down and equity returns higher as price-to-earnings ratios expanded.
With increasing confidence in U.S. corprations and the Fed’s exit, investors have begun moving capital out of foreign economies back into the U.S. This is causing foreign stock markets to fall, sending emerging markets down 6.5 percent recently.
The implication of such actions for emerging economies such as Argentina, Turkey, Brazil and many others is that it will cost more to borrow money and fuel investment in infrastructure and technology.
The shortage of U.S. dollars flocking into foreign countries and causing higher borrowing costs will make projects less profitable and ultimately stifle domestic growth in the aformentioned markets.
European markets may be at a bottom and presenting a buying opportunity for investors. Worries out of nations such as Italy and Spain continue to cause doubts about such investments.
According to Bill Gross at PIMCO, with proper strategy in fixed income markets individuals can return three to four percent this year. For those looking to attain greater returns, U.S. and European markets are ripe for additional growth.
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