2013 Annual Review: What Can 2013 Teach Us About Stock Market Behaviour?

The year 2013 was punctuated by a series of unsettling economic events. Unemployment remained high, growth was lacklustre, and even the U.S. government shut down for few weeks—all of which was anxiety provoking to say the least.  You might assume that what followed, naturally, was a year of poor returns for frustrated equity investors.

But you would be wrong. Despite these apparent setbacks, 2013 was a stellar year for equities, with many major asset classes posting very strong returns. Leading the way were U.S. stocks, returning over 40%, followed by EAFE (Europe and developed Asia) stocks at 31%. The laggards were Canadian stocks at just over 14% and the Emerging Markets at 4.5%. (See full return chart on page 2).

That might seem like a head-scratcher—until you recall that stock market performance does not necessarily align with current events or the headlines that trumpet them. The big lesson from 2013 is that stock market returns are based on how the economy performs relative to expectations. If expectations (even low ones) are exceeded, the market responds positively. If they’re not met, returns will be weak.  Although last year was a dreary one for most economies, the U.S. performed better than expected—hence a year of great returns for that stock market. (Based on this reasoning, maybe we can start to expect good returns from Canada and the Emerging Markets this year?).

Looking ahead                                                      

But pop the champagne cork cautiously. There are two possible perils in this situation (both easily avoided now that you’ve been forewarned). First, these are the kinds of returns that can tempt normally level-headed investors to make bad choices as they chase performance—whether getting caught in a fad in an up market, panic selling in a down market, or trying to time the market.  Avoid “headline investing”—it’s the media’s job to report on economic ups and downs, but responding to the daily news by pressing the buy or sell button is a recipe for poor performance in the long run (and sleepless nights in the short run).

Secondly, remember that March 2014 will mark the five-year anniversary since one of the worst stock market declines in history. Come March, the starting point for 5-year returns will be very, very low, so past returns will look extremely attractive. For example, from January 1, 2009 to December 31, 2013 the return for U.S. stocks was 14.78% per year. If we move the start date to March 1, 2009 (within days of the stock market bottom), the returns jump by almost 5% to 19.1% per year.

Don’t think for a minute that the Wall & Bay Street marketing machines aren’t fully aware of this fact. Most will cherry pick the best returning funds in their stables in an effort to lure investors in—after a period of superior performance. Beware these biased marketing strategies.

Acknowledging volatility

The year 2013 also offers investors a worthwhile reminder of the need to cope sensibly with volatility. While unexpected economic or political events (such as the U.S. government shutdown) can cause volatility to increase—note that in a typical year, equity volatility is 15% from peak to trough—historical data show that sticking to a well-thought-out investment plan based on your goals, time frame and risk profile is the wisest approach. Remember, volatile is not a synonym for negative.  An investment that surges 30% is just as “volatile” as one that goes down by the same amount. Volatility is not the enemy—but a knee-jerk response to volatility can hurt you. The key to long-term investment success is to accept short-term fluctuations, knowing that if you stay the course, you’ll likely reap the rewards (see sidebar above).

The bottom line: 2013 was a stellar year, and it’s okay to celebrate. But investors are well advised to continue to temper their expectations: market corrections do happen. The key to surviving them is not to be surprised. In summary, get comfortable with the idea that short-term volatility is normal; don’t move the goalposts; and do stay diversified.

Major Asset Class Returns to December 31, 2013

 

6 Months

1 Year

3 Years

5 Years

10 Years

Cash

0.50%

0.96%

0.92%

0.71%

1.91%

Canadian Bonds

0.50%

-1.19%

3.93%

4.78%

5.16%

Canadian Stocks

14.0%

12.99%

3.40%

11.92%

7.97%

U.S. Stocks

17.45%

41.65%

18.65%

14.78%

5.32%

Int’l Stocks

16.64%

24.22%

7.81%

9.75%

5.37%

REITs (Canadian)

0.06%

-5.52%

10.37%

20.68%

10.25%

Notes:

1)      Data Source Dimensional Fund Advisors, iShares (BlackRock).

2)      Asset Classes:  Cash – Canadian One Month T-Bills; Canadian Bonds – DEX Bond Universe; Canadian Stocks – S&P/TSX Composite    Index, US Stocks – S&P 500; International Stocks – MSCI EAFE plus Emerging Markets; REITs – S&P/TSX Capped REIT.

3)      Returns longer than one year are annualized.

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