In 2013, investors who blocked out the scary headlines about a possible government default, budget cuts, and concerns about when the Federal Reserve would begin to scale back its stimulus, did great. The economy wasn’t robust, but it wasn’t weak either. Earnings grew, even if companies achieved them by cutting costs rather than increasing sales. And the Fed gave the market a year-end bonus by keeping short-term borrowing costs near zero, even after dialing back its program to hold down longer-term rates.
Final tally: Stocks are up more than 28 percent.
The worrier’s ultimate refuge – cash, bonds, and gold – actually caused even more heartburn. Havens like bonds are down this year: The biggest category of bond funds by assets, intermediate-term bond funds, has lost an average of 1.5 percent.
Market strategists, on average, see more modest growth for stocks in 2014. The S&P 500 could rise 5 to 7 percent. Bonds should continue to struggle as interest rates are expected to rise.
Here are the positives from 2013 and some tempering thoughts for 2014.
SMALL CAPS WERE BIG: Here’s where the stock optimists really shone. The Russell 2000, an index that tracks smaller, riskier stocks, is up nearly 37 percent, more than the Dow and the S&P 500.
STUNNING DEBUTS: IPOs are risky and also for positive thinkers. And they surged this year. The number of initial public offerings rose to its highest since 2000. When stock prices rise steadily and strongly, companies have incentive to roll out their stocks to the public. And investors want those new shares. The average IPO stock rose almost 35 percent this year, outperforming the S&P 500, according to data from Renaissance Capital. In total, companies sold $55 billion of stock in 2013, an increase of 29 percent from 2012.
NO HOLDING BACK: Another streak for bulls. The S&P 500 has gone 27 months without a downturn of 10 percent or more. That compares with an average streak of 18 months between such declines, according to S&P Capital IQ.
Investors who sat out the rally in stocks are now left with a quandary. Do they buy now, with stocks more expensive, or do they stay on the sidelines and risk being left further behind?
WATCH OUT FOR CROWDS: After being burned during the financial crisis, many investors have stayed away from this five-year bull market. Investors pulled $430 billion out of stock funds, according to data from Lipper, while putting nearly $1 trillion into bond funds since the market bottomed in March 2009.
Professional investors worry that the average Joe will now try to make up for lost time in 2014. If large numbers individual investors jump, the demand could inflate prices beyond what earnings justify. That could lead to what Wall Street call a “melt-up,” which almost always leads to a “melt-down.”
WHAT GOES UP, MUST COME DOWN: Goldman Sachs analysts see a 67 percent chance that stocks will decline 10 percent or more in 2014, which is known as a stock market “correction.” The S&P 500 is up nearly 40 percent since the stock market’s last major downturn in October 2011. Still, Goldman analysts still expect stocks to end next year modestly higher.
LOWER EXPOSURE: 2014 is not looking good for bond investors. With the Fed starting to pull back on its bond purchases in January, one of the biggest buyers of bonds for the last year will slowly slip out of the market. That could send bond prices lower.
Bond investors should tweak their portfolio to focus on shorter duration bonds, says Richard Madigan, chief investment officer for JPMorgan Private Bank.
He would normally tell investors to have bonds that mature in average of about five years. For 2014, Madigan is advising them aim for average duration of two to two-and-a-half years.
“Long duration bonds are much more a riskier asset than a safe asset next year,” Madigan says.