Bill Miller Letters Archive

2013 Q4 – Market Commentary

On a recent appearance on Consuelo Mack’s Wealthtrack, Consuelo asked what I thought the biggest surprise in 2014 might be. My response was that as a contrarian investor, it was that the bullish consensus would be correct. Usually, when there is a broad consensus among capital markets participants, that view is already reflected in prices, and even if fundamentally accurate is not thereby sufficient to move prices further. Going into 2014, the mood among strategists and portfolio managers is markedly different from that which prevailed a year ago. Then, caution was the watchword, as worries about the fiscal cliff1, about payroll tax hikes, about sequestration2, about the debt ceiling3, about a government shutdown, about potential Federal Reserve (Fed)4 tapering5, about tepid earnings growth, about a potential hard landing in China and about deflation in Europe — just to mention a few — all conduced to keep expectations low and caution high. We all know how those worries played out: the S&P 5006 rose over 30% and put in its best showing in 15 years. Going into 2014, it’s different.

There appears to be broad consensus that the stock market will continue climbing, albeit no one that I have seen is predicting a year like 2013. My anecdotal scan of strategists and portfolio managers looks like the prevailing view is for stocks to perform in line with expected earnings growth.

If the market does go up somewhere in that range, it will be uncommon. As Jason Zweig noted in the Wall Street Journal recently, although the market’s average annual increase has been about 10% since good data began being kept, it rarely provides yearly returns at that exact level. When it has gone up it has almost always gone up more, and when it hasn’t it almost always has gone down7.

If that pattern holds, what should we expect in 2014? The answer is: more. The market’s average annual return is a calculation that includes all the down years as well as the up years. Historically, when the market has not been down, though, its average annual return has been over 15%8. What are the chances 2014 will be a down year? Well, there is such a chance, but it looks very low. Market declines are almost always a result of some combination of three things: oil price spikes, recession, or Fed tightening. Oil prices have been falling in early 2014 and the supply-demand balance is such that unless there is a significant supply disruption, prices should be broadly stable. Not only is no recession in sight, economic growth estimates have risen recently to over 3% as the preponderance of economic numbers has been stronger than expected. Finally, the Fed has said they will pin short term interest rates near zero for the next year or so, and while slowing their asset purchases, they are still injecting net liquidity into capital markets.

The question, though, remains: if the broad consensus is for a good stock market in 2014, why is that not already in current prices? After a 30% gain in 2013, to some extent it is. But while pundits say they expect solid gains in stock prices, the behavior of investors still indicates a high degree of skepticism about the behavior of stock prices. Asset allocations of pension plans and endowments are still heavily skewed toward bonds and alternatives, while a recent survey of Citibank’s high net worth clients indicated stock allocations at around 25% and cash approaching 40%, positioning which is extremely conservative, in my opinion.

In 2013, we saw the beginnings of a broad asset allocation shift from bonds to stocks, as bond funds saw redemptions and stock funds saw inflows for the first time in years. I believe this will continue in 2014, and perhaps accelerate if the longer term interest rate moves higher along with stock prices. This could provide the fuel for a very solid year for the stock market, consistent with its behavior in prior up years.

What could derail this happy outlook? Lots of things. A faltering housing market, a worse than expected labor market, geopolitical flare ups, and interest rates that rise much faster than expected are just a few of a long list of potential risks to stock prices moving higher. But there are always risks and worries; the investor’s job is to assess the range of the evidence and allocate assets accordingly.

Bull markets are driven by three broad elements: economic growth, ample liquidity, and attractive valuation. The economy is growing, liquidity is not only ample but increasing, and valuation, while not as attractive as a year ago, is undemanding in my opinion, and well below levels that typically occurred at important peaks.

We believe the bull market that began amidst great pessimism in March 2009 looks set to continue in 2014.

Investment Risks

All investments are subject to risks, including loss of principal. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges.

The opinions and views expressed herein are those of the portfolio managers and may differ from those of other managers and are not intended to be relied upon as a prediction or forecast of actual future events or performance, or a guarantee of future results, or investment advice.

Common stocks generally provide an opportunity for more capital appreciation than fixed-income investments but are subject to greater market fluctuations.

Fixed income securities are subject to interest rate and credit risk, which is a possibility that the issuer of a security will be unable to make interest payments and repay the principal on its debt. As interest rates rise, the price of fixed income securities falls.

Foreign securities are subject to the additional risks of fluctuations in foreign exchange rates, changes in political and economic conditions, foreign taxation, and differences in auditing and financial standards. These risks are magnified in the case of investments in emerging markets.

Commodities contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

Asset allocation does not assure a profit or protect against a loss.