2014: The year stock “ons" were “off”

In speaking with investors, I’m frequently surprised by the divergence between their perception of stock market returns and the actual returns markets are posting. In my experience, the difference often lies in the fact that many investors are basing their feelings about the market on what they’re hearing and seeing in the news headlines. Like most years, 2014 had no shortage of sensational storylines that could make the average investor justifiably nervous. Think Crimea, Ebola, ISIS, Malaysia Airlines crashes, for instance. In actual fact, though, 2014 was not only a year of positive U.S. stock market returns (as measured by the S&P 500^® Index) – it was the sixth consecutive year of positive calendar-year returns.  A few statistics and the exhibit below may help bolster their confidence:

• U.S. stocks (S&P 500^® Index) have posted positive calendar-year returns 73% of the time since 1926. Historically, investors have been more likely to be rewarded by investing in U.S. stocks in any given calendar year, than hurt by that allocation.
• Using history as a guide, there doesn’t appear to have been any pattern regarding the positive and negative years: it’s been extremely challenging to time in which calendar year U.S. stocks may finish above or below zero.
• The last time U.S. equity investors experienced a negative calendar-year return was in 2008. Granted, it was a whopper and memories of that period are still etched in many investors’ memories – but investors have enjoyed six years of positive U.S. equity calendar-year returns since then.

Represented by the S&P 500® Index from 1926-2014 Index returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment. Indexes are unmanaged and cannot be invested in directly. Going beyond the average But focusing simply on the average return for the year masks what was going on below the surface – in the economy and the individual equity market sectors and styles. What were some of the key drivers of the 2014 11.56% calendar-year return? (measured by the Russell 3000® Index) The economic backdrop – and the market expectations it shaped Heading into 2014, many market observers anticipated that the U.S. economy would continue on its path of recovery with the unemployment rate to continue improve, inflation to remain low and the U.S. energy sector to continue its strength of the prior year. These drivers also led many to believe that interest rates would rise during the year and cyclical or pro-growth equity sectors to be among the top performing. What actually happened during the year? Most of the expectations were realized except for two big ones:  the path of interest rates and the energy sector.

• Instead of increasing, the yield of the U.S. 10-Year Treasury declined throughout the year. This reduction wound up being a boon for those sectors that are typically more defensive and/or sensitive to interest rates – for instance, utilities, REITs, Health Care. And, despite the political debate around Health Care, it was the best performing equity sector in 2014, as shown in the chart below (based on the Russell 3000® Index equity sectors).

• The sharp drop in the oil price – especially in the second half of the year – had a significant impact on energy-related investments. The energy sector was the only one to post negative calendar-year returns within all of the U.S. equity sectors.

One of the most surprising elements of U.S. equity markets in 2014 was the degree to which the leadership at the stock level was narrow. Source: Russell Investments, U.S. Equity: Russell 3000® and Russell 3000® equity sectors. Five stocks everyone would have wanted to own… In 2014, five companies – Apple, Microsoft, Berkshire Hathaway, Intel and Wells Fargo & Co. accounted for 17% of the calendar-year return of the Russell 3000 Index – which is made up of 3,000 companies. Apple alone accounted for 8% of the total return.  Five out of three thousand is pretty narrow leadership.  If a U.S. equity portfolio did not include those companies at least the same weight as the Russell 3000 Index, the portfolio likely would have had a tough time outpacing the benchmark. …and the five everyone would have liked to avoid Amazon, Exxon Mobil Corp., IBM, General Electric and Chevron were the largest detractors within the Russell 3000 Index in 2014. Notice that the names of three of the five largest detractors end with “on.” Which makes 2014 the year in which “ons" were “off.”