2014: An Orwellian Year?

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With January 2014 now in the record books, and the first trading day of February looking particularly ugly, investors are naturally becoming worried as to what might be in store for the rest of the year. For the statistic junkies among you, the MSCI World index fell -4.4% in January, making it the worst month in well over a year. Today’s big drop is adding to January’s losses; as I write this, the MSCI World index is now down -6.4% for the year, and the lion’s share of that loss has occurred in just 6 trading days. “What’s next?” you ask.

If you’re a regular reader, you know that short-term stock price movements are mostly random, which is why “past performance does not predict future results.” Today’s big decline was likely triggered by a surprisingly large drop in the ISM manufacturing survey; however, this report is likely an outlier owing to an unusually cold January. But once the decline began, it fed on itself and selling begat selling. In the end, there really doesn’t need to be a reason for investors to hit the “sell” button.

And forget the so-called “January indicator,” which says that as goes January, so goes the year. This indicator has a perfectly random record: in other words, stocks go up after a down January as often as they go up on average. Whether January is up or down thus has no effect on the remainder of the year. Better to follow another useless indicator, which supposedly predicts the market by looking at who wins the Super Bowl. Fortunately, a Seattle win means a good year for stocks. Better yet, flip a coin. It will be just as accurate as these silly indicators.

This year marks the 30th anniversary of the annum featured in George Orwell’s famous novel, 1984. It’s remotely possible that 2014 will look something like that year, at least in the stock market (will the NSA be watching as well?). Although history rarely repeats, particularly in investing, it does often rhyme. And 1984 started out very similarly to this year, with a big drop in the market from early January through mid-February that took the S&P 500 index down -8.9%. (The somewhat good news is that, if the declines end up being similar, we’re already 2/3 of the way there.)

Cracks below the surface

1983 had been a good year, with the S&P 500 up +22.6%. And that was on top of a +39.4% gain from the bottom of the 1982 bear market. So a correction should not have been a surprise. In addition, while the large-stock indexes had basically been treading water since June 1983, small stocks had been in a bear market, declining almost continuously through the end of the year. It took until January 1984 for big stocks to catch the same cold.

This time, US small stocks have been doing very well, while the sick man of the market is represented by emerging countries like China and Brazil. They’ve been in a bear market for over 2 ½ years now and remain some -25% below their 2011 highs. It took a while, but perhaps developed countries are starting to pick up the sniffles as well. If so, it’s certainly possible that once the current decline runs its course, emerging markets may lead stocks upward rather than the US. Time will tell.

So what happened after February 1984?

You’re probably wondering what US stocks did in 1984 after that awful start. The short answer is: not much. After staging a solid recovery of +4.9% through early May, the resumed their declining ways by dropping another -8.7%, bottoming in mid-July at just shy of -10% down for the year. The January indicator fans were cheering at this point, vindicated. (Perhaps you sports fans remember who won the Super Bowl in 1984.)

But then the market rallied, with the S&P 500 shooting up +13.5% in less than a month. It treaded water from there, ending the year up a boring +1.4% (+6.3% including the hefty dividends of the day). Not much progress in either direction for what started out as a volatile year.

I’m not saying that 2014 will look just like 1984. I’m just trying to illustrate how sharp stock price movements in either direction are hardly predictive of longer-term returns. 2014 could certainly be a disappointing year for US stocks after a great 2013. But even if domestic stocks struggle, foreign ones could shine. Perhaps those sickly emerging markets will finally heal themselves and jump out of bed. Anything can happen.

By the way, after a middling 1984, investors enjoyed a profitable 1985, with the S&P 500 returning a hefty +31.7%. And that was just year 4 of what ended up being an 18-year bull market. As I’ve stated before, I believe that the secular bear market that began in 2000 is over and we’re again in the early years of a bull market that should last a decade or more. If so, enjoy the ride, bumps and all.

Dr. Ken Waltzer MD, MPH, AIF®, CFA, CFP®
Founder and President – Kenfield Capital Strategies (KCS)

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