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2013 was great for S&P; now forget it

by Community Manager

‎05-21-2014 10:59 AM

market commentaryBy Bernie Williams, chief investment officer, investment solutions

 

Among the questions we hear most when speaking with members is “Why doesn’t my stock portfolio keep up with the S&P 500? It was up 30-something percent last year, so why was I only up 19 percent?”

 

We’re not the only ones getting these questions. Most every investment manager who was not 100 percent allocated to the U.S. stock market is probably having the same discussion with their clients. And even as we get close to the midway point of 2014, with the Standard & Poor’s 500 index barely in the black so far this year, it seems that many investors are still focused on the profits they didn’t make in 2013.

 

Last year was an exceptionally good year for U.S. stocks. More to the point, it was one of the handful of best years for U.S. large caps and small caps going back to the end of World War II. And this standout performance came as a big surprise, given iffy economics (slow GDP growth, stubborn unemployment), political issues (government shutdown, beginning of the end of loose monetary policy) and corporate fundamentals (scant revenue gains, narrowing margins).

 

No matter the unusual circumstances, we understand that after a year like 2013, U.S. investors who didn’t catch all of the upside have lingering regrets. They kick themselves for not keeping their money close to home, especially since stocks elsewhere didn’t do nearly as well. For emerging markets, performance was negative for the year.

 

Forgotten in this self-reproach are the recent lean times for U.S. stocks. Just four or five years ago we were hearing a different question: “Are U.S. large caps dead?” The question wasn’t unreasonable — for the decade ending in December 2010, the S&P 500 rose an average of about 1 percent per year. Over the same time period, emerging markets stocks were on a tear, with yearly gains averaging more than 13 percent.

 

The contrast of then and now makes for a good illustration of why we believe in the long-term benefits of global diversification. At USAA, we have spread our investment portfolios across both developed and emerging markets to make sure we don’t have too much exposure to the fortunes (and misfortunes) of any single country, asset class or market sector.

 

Diversification is a key component of risk management — an investor’s willingness to give up some of the positive returns of an asset or market over a given time period as a way to protect the overall portfolio during those times when the asset or market has negative returns. Many investors are less receptive to the concept of diversification when the U.S. market is soaring, but that doesn’t make it any less relevant or important.

 

Those who study investor behavior have identified a couple of related tendencies that come into play at times like this. One is known as “recency bias,” which is when investors let themselves be influenced more by recent events than by long-term trends. The other is “action bias,” the sometimes overpowering urge that says, “Don’t just sit there; do something!”

 

These behavioral biases can lead investors to make abrupt and often significant changes to their long-term asset allocation (action bias) in order to chase the performance of assets that have done well lately (recency bias). Either alone or in combination, giving in to these biases can hurt performance in the long run.

 

We don’t think this is the time to load up on U.S. equities or to shun emerging markets. In fact, we are starting to increase our overweight to emerging markets and overseas equities in general due to their more attractive valuations.

 

In the U.S., GDP growth for the current quarter is expected to be around 3.5 to 4 percent, and the forecast is 3 percent growth in the third and fourth quarters. Earnings growth for the year for U.S. companies is projected at 7 to 8 percent. Taken together, this isn’t too bad, but it’s hard to see how the S&P 500 can post yet another year of double-digit gains. For that to happen, we would have to have another year of major expansion of price multiples (price-to-earnings, price-to-book-value or price-to-cash-flow ratios), and we don’t see that as being likely. This reasoning underlies our underweight position in U.S. stocks.

 

Meanwhile, emerging markets — last year’s laggard — are showing signs of recovery. Since bottoming out in early February after a currency scare in the so-called “Fragile Five,” emerging markets are up more than 13 percent. Economic growth is picking up in many countries (China being an exception), and the prospect of quantitative easing by the European Union could provide a liquidity boost. Looking at fundamentals, emerging markets stocks are trading at P/E ratios much cheaper than the U.S. or other developed markets.

 

History makes it clear that the best investment opportunities aren’t always in the U.S. After an off-the-charts 2013, 2014 could be one of those years.

 

USAA Investments Managed Portfolio Outlook

Our view of caution toward U.S. equities remains unchanged — we are underweight U.S. large caps and small caps. While signs point to continued recovery of the U.S. economy, valuations are stretched and profit margins are near record highs. The USAA Income Stock Fund seeks dividends and dividend growth as contributors to total return.

 

We are tactically underweight fixed income, primarily to fund a deployable cash position. Within fixed income, we prefer areas of the market that are more credit-sensitive and less sensitive to changes in interest rates, such as investment-grade corporate bonds and high-yield bonds. The USAA Intermediate-Term Bond Fund and the USAA High Income Fund fit this profile.

 

We are overweight to assets that are positively correlated to inflation expectations. The USAA Real Return Fund provides potential protection against the risks of long-term inflation.

 

We are overweight non-U.S. developed markets and emerging markets based on relative valuations. Though they have been hit especially hard recently, we believe that emerging markets remain attractive. Along with compelling valuations, they offer an interesting long-term prospect for growth. The USAA Emerging Markets Fund offers exposure to stocks in less-developed countries.

 

As always, we encourage investors to speak with one of our financial advisors, who can help determine which investment vehicles are best suited for your individual goals, objectives, risk tolerance and time horizon.

 

This material is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing.

 

Consider the investment objectives, risks, charges and expenses of the USAA mutual funds carefully before investing. Contact us at 1-800-531-8910 for a prospectus containing this and other information about the funds from USAA Investment Management Company, Distributor. Read it carefully before investing.

 

Investing in securities products involves risk, including possible loss of principal.

 

Past performance is no guarantee of future results.

 

As interest rates rise, existing bond prices fall. Non-investment grade securities are considered speculative and are subject to significant credit risk. They are sometimes referred to as junk bonds since they represent a greater risk of default than more creditworthy investment-grade securities. 

 

Some income may be subject to state or local taxes or the federal alternative minimum tax.

 

Foreign investing is subject to additional risks, such as currency fluctuations, market illiquidity, and political instability. Emerging market countries are most volatile. Emerging market countries are less diverse and mature than other countries and tend to be politically less stable.

 

The S&P 500 Index is a well-known stock market index that includes common stocks of 500 companies from several industrial sectors representing a significant portion of the market value of all stocks publicly traded in the United States. Most of these stocks are listed on the New York Stock Exchange.

 

Standard & Poor’s 500 Index and S&P are registered trademarks. The S&P 500 Index is an unmanaged index of 500 stocks. The S&P 500 focuses on the large cap segment of the market, covering 75% of the U.S. equities market. S&P 500 is a trademark of the McGraw-Hill Companies, Inc.

 

The Russell 2000® Index is an unmanaged index which consists of the 2,000 smallest companies in the Russell 3,000 Index, and is a widely recognized small cap index.

 

USAA or its affiliates do not provide tax advice. Taxpayers should seek advice based upon their own particular circumstances from an independent tax advisor.

 

High double digit returns are attributable, in part, to unusually favorable market conditions and may not be repeated or consistently achieved in the future.

 

Financial planning services and financial advice provided by USAA Financial Planning Services Insurance Agency, Inc. (known as USAA Financial Insurance Agency in California, License #0E36312), a registered investment adviser and insurance agency and its wholly owned subsidiary, USAA Financial Advisors, Inc., a registered broker dealer.

Investments provided by USAA Investment Management Company and USAA Financial Advisors Inc., both registered broker dealers.

 

The Real Return Fund may be subject to stock market risk and is non-diversified which means that it may invest a greater percentage of its assets in a single issuer. Individual stocks will fluctuate in response to the activities of individual companies, general market, and economic conditions domestically and abroad. When redeemed or sold, may be worth more or less than the original cost.

 

Managed Accounts is a service of USAA Investment Management Company (USAA), a registered investment adviser and broker dealer.

 

Diversification does not guarantee a profit or prevent a loss.

 

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Community Managers

Briana Hartzell

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Wendy Poling

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Charles Pratt

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Charles "Chazz" Pratt III is a former U.S. Army Captain who made the Military-to-Civilian career transition in 1994. In his book, The Fort Living Room Transition Course, he shares valuable tips & tricks to help you succeed. Since his transition from the military, he's worked for several Fortune 500 companies, including Pfizer, Genentech, and St. Jude Medical, among others.

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Joseph Montanaro

Joseph "J.J." Montanaro

Joseph "J.J." Montanaro is a CERTIFIED FINANCIAL PLANNER™ practitioner.

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