Don't Know Much About History
Sam Cooke spoke for many high school students of the 1960's when he sang the words of today's title as part of his hit song Wonderful World. In college, however, we learned about philosopher George Santayana and his much earlier book Reason in Common Sense. In it, he wrote: "Those who cannot remember the past are condemned to repeat it".
In last week's article, I offered a look at the history of market cycles but this week, I'd like to look more closely at 2013 to see if we can learn anything that might offer guidance for 2014.
2013 was the 17th year since 1926 during which the S&P 500 had at least a 25% gain. Have markets generally repeated that great performance the following year? Five of the follow-up years enjoyed further significant gains while six had declines. The best was a 27% increase and the worst a 39% decrease with an average of a 6% gain. This certainly doesn't tell us what's going to happen in 2014 but it does remind us that what goes up may or may not go up again.
Although owners of gold had enjoyed twelve terrific years, 2013 was a tough one for them. Gold's price peaked at just over $1900 per ounce in 2011, fell in late 2011 and early 2012, then rebounded to about $1800 in September. It then began an eighteen month slide and ended 2013 around $1240. While stock investments can be thought of as a way to capture the future earnings of the companies in which you invest, gold is a play on both the potential need for the metal in manufacturing and its desirability as a decoration. In addition, some pundits loudly proclaim it a safe haven from runaway inflation, an idea that proved to be of little value last year as both interest rates and inflation remained benign.
Several other commodities did no better. Corn is very important to Hoosiers and its price has fallen around 50% in the past eighteen months. Like gold, corn's value is influenced by more than one factor. I have commented before that part of its run-up was probably related to the Congressional mandate to blend ethanol into the gasoline we use in our cars. As that mandate is being debated, corn's price has slipped. Of course, it's also a staple of our food supply and one we export around the world. As other countries' harvests wax and wane, the price of corn adjusts accordingly. Right now, many farmers are storing corn instead of selling it. This reduces the current supply and tends to support prices.
2013 was not a great year for hedge funds. Hedging involves using an offsetting investment to reduce the risk to one you already own. For people or institutions with extremely large investment portfolios, it sometimes makes sense to use a narrowly-focused fund instead of making hedges within the regular account. Headlines about these funds were common back in 2008 when some of them placed bets which paid off handsomely during the market's correction. This attracted a lot of publicity and these specialty funds began to be offered for much smaller investors, some of whom may not have clearly understood their function. As the S&P 500 gained around 30% in 2013, the Bloomberg Hedge Fund Index had a return of about 7.5%. Investors who didn't know exactly why they owned them and expected large gains every year were disappointed. Because we are believers in asset allocation, our investment portfolios are hedged as a matter of course. A diversified portfolio which includes investments in stocks and bonds in various percentages will not perform as well as the stock market alone in its best years. That's a cost we believe is worth absorbing because we know that this strategy will protect our clients from the worst effects of a market correction.
Last fall's rollout of the Affordable Care Act has been widely panned but it's far from the first government program to be less than popular at the time of its introduction. Medicare is the keystone of almost all retiree health coverage but most of us have probably forgotten this 1965 headline from the New York Times: Selling Elderly on Medicare Is Not Easy. In order to encourage people to sign up for the program, government employees eventually went door-to-door offering to help people with the paperwork. Today, most retirees' prescriptions are subsidized by Medicare Part D coverage but when George Bush added the program in 2006, current House Speaker John Boehner (also a Republican) called the idea "horrendous". Then, as now, website malfunctions were in the news but today our office uses Medicare's highly functional website to research and recommend supplemental insurance policies to our clients.
Other difficult introductions include the Peace Corps, the income tax and the Social Security system itself, all of which are operating reasonably smoothly today. This is no guarantee that the ACA will succeed but history suggests that result is more likely than not. Speaking of the government and its programs, let's loop back to the first few weeks of October 2013. Do you remember headlines predicting horrible outcomes following the government shutdown? Although our national parks and some government offices were closed, most Americans were little affected and life seems to have returned to (what passes for) normal.
How will any of these snippets from recent history help us in 2014 and beyond? Well, I hope being reminded that few major programs come into being without incident will help us draw back from the headlines. Perhaps we can begin to think past the world of "breaking news" and allow a longer-term perspective help us live our lives less stressfully. Perhaps, if we give the issues in today's headlines more time to resolve themselves, we might also be able to insulate ourselves from being swept up in whatever craze infects investors this year.