A number of economic conditions influenced capital market returns in 2014, but three themes
played particularly large, and somewhat surprising, roles during the year.
- Interest rates falling instead of rising
- Relative strength of the U.S. dollar
- Oil prices falling over 40% during the year (as measured by the Dow Jones Commodity Index for Brent Crude)
We entered 2014 with the 10-Year U.S. Treasury yield hovering around 3.0%. General expectations, including Russell’s, were for interest rates to move gradually upwards through the year as the U.S. economy continued to show improvement. The economy delivered as the year progressed, but rates moved in the opposite direction
and the 10-Year U.S. Treasury finished the year yielding approximately 2.2%.1
This had a significant impact of interest rate sensitive assets. The U.S. Bond market exceeded most early expectations with a 6.0% return for the Bloomberg U.S. Aggregate Bond Index for the calendar year 2014. The Bloomberg Municipal Bond Index was up 9.1% and long Treasuries did the best of all, up 25.1% as measured by the Bloomberg Aggregate Government-Treasury Long Index for the 12-month period ending December 31, 2014.
Other assets benefitting from the lower interest rate environment included Global REITs and Global Infrastructure. Both tend to be among the higher yielding equity assets and this attracted attention from investors
seeking yield. Global REITs, as measured by the FTSE/EPRA NAREIT Index, were up 15.0%, and infrastructure followed closely behind at 12.3% as measured by the S&P Global Infrastructure Index for the calendar year. These results came despite the headwind of 2014’s strengthening U.S. dollar.
Strengthening U.S. Dollar
The U.S. continued to lead the recovery from the global recession
and in 2014 this was reflected in both equity returns and economic momentum. An outcome of this success was an increased demand for U.S. dollars. This increasing demand, combined with other nations’ attempts to weaken their own currencies, saw a significant rise in the relative strength of the U.S. Dollar in 2014.
The U.S. equity market reflected this strength
with the Russell 3000®
Index up 12.6% for the year. From the perspective of USD-based investors, non-U.S. equity markets did not fare as well, with the Russell Developed ex-U.S. Large Cap Index down -4.0% for USD-based investors. However, in local market currency terms, that same Russell Developed Index was up near 6% for the year. In 2014, the strengthening U.S. Dollar cost USD investors close to 10% on their non-dollar developed equity investments. It just goes to show what an impact the relative strength of different currencies can have.
Similar impacts were seen in emerging market equities
as the Russell Emerging Markets Index was down -1.7% for the year in U.S. Dollar terms, but up close to 5% in local currency terms.
While few investors anticipated interest rates to fall in 2014, probably even fewer expected the price of oil to drop by over 40%, as measured by Brent Crude Oil Commodity Futures – with most of the decline hitting in the last six months of the year. This had a mixed impact on capital market returns, but two outcomes
- The Energy sector was by far the weakest sector in equity market returns globally. In fact, within the Russell 3000 Index, the Energy sector was the only negative sector for the 4th quarter (-13.3%) and the year (-10.1%).
- Commodity returns were severely impacted. With Energy-related sectors down over 40% for the quarter, the Bloomberg Commodities Index was down -12.1% for the final quarter of 2014 and -17.0% for the year.
Sources: U.S. Equity: Russell 3000® Index, Non-U.S. Equity: Russell Developed ex-U.S. Large Cap Index, Emerging Markets: Russell Emerging Markets Index, U.S. Bonds: Bloomberg U.S. Aggregate Bond Index, Global REITs: FTSE EPRA/NAREIT Developed Real Estate Index, Commodities: Bloomberg Commodities Index, Balanced: 30% U.S. Equity, 20% Non-U.S. Equity,5% EM, 35% Bonds, 5% REITs, 5% Commodities.
Asset Class Dashboard – as of December 31, 2014
After 2013’s outsized results in which U.S. large cap and small cap equities, global equities, and U.S. bonds were all exceeding or at extreme ends of the typical historical ranges, 2014 had a little bit more of a “normal” feel. Every asset class posted a return within its typical twelve month historical range with two exceptions: cash and commodities
. The historically low interest rate environment has kept cash returns below normal for a number of years now and 2014’s pull back in oil prices led to a historically bad year for commodities.
Large cap U.S. equity: Russell 1000 Index, Large cap Defensive U.S. equity: Russell 1000 Defensive Index, Large cap dynamic U.S. equity: Russell 1000 Dynamic Index, Small cap U.S. equity: Russell 2000 Index, Non-U.S. Equity: Russell Developed ex-U.S. Large Cap Index, Global equity: Russell Developed Large Cap Index, Emerging markets: Russell Emerging Markets Index, Commodities: Dow Jones – UBS Commodity Total Return Index, Global infrastructure: S&P Global Infrastructure Index, Global real estate: FTSE EPRA/NAREIT Developed Index, Cash: Citigroup 3-Month U.S. Treasury Bill Index, Global high yield bonds: Bank of America Merrill Lynch (BofAML) Global High Yield Index, Emerging markets debt: JP Morgan Emerging Markets Bond Index Plus, U.S. bonds: Bloomberg U.S. Aggregate Bond Index.
How do I read this chart?
This dashboard is intended as a tool to set context and perspective when evaluating the current state of a sample of asset classes.
The ranges of 12 month returns for each asset class are calculated from its underlying monthly index returns. The stated inception date is the first full month of an index's history available for the dashboard calculation.
Here is how to read the graphic on this page:
FOR EACH INDICATOR, THE HORIZONTAL BAR SHOWS FOUR THINGS
A GRAY BAR shows the full range of historical rolling 12?month returns for a sample of asset classes.
A BLUE COLOR BAND represents the typical range (one standard deviation away from the mean, i.e. 68% of historical observations) of rolling 12-month returns for these asset classes.
AN ORANGE MARKER represents the most recent 12?month return of the asset classes.
A WHITE LINE within the blue bar represents the mean of the historical observations.
The bottom line
The surprise – and impact – of rising interest rates, falling oil prices and relative strength of the U.S. Dollar in 2014 were good reminders for investors that it can be very difficult to anticipate what is coming next for the markets and economy. Although diversification cannot guarantee a profit or protect against loss, it has historically helped temper the impact of unexpected changes, making it easier for many investors to stick to their long-term plans and eventually meet their financial goals.