market view

BOND BEAR MARKETS NOT SO BADOn the fi xed-income front, the Barclay’s U.S. Aggregate Bond index lost 2.02% for the year—not bad, considering many investment professionals feel we are in the midst of a bond bear market. The Federal Reserve has begun the tapering off of its bond buying strategy, which is expected to put added downward pressure on bond prices. The tapering off of the bond buying program is expected to continue to fuel a bond bear market.

In previous Market View newsletters we have tried to calm the fears of investors and put into perspective exactly what a bond bear market means. In one newsletter, we looked back at the last three bond bear markets and concluded that the bond bear market was not as devastating as one might expect. In this edition of Market View we would like to take a different approach and look at the last secular bond bear market.

The bond market is no different than the stock market in that prices move in both secular (5-30 year) cycles and cyclical (1-4 year) cycles. While the movement is the same between equity and bond markets, the severity of a downturn is not. There is no doubt that interest rate risk can result in near-term losses, but those losses do not necessarily have to be substantial, and history indicates that the most severe losses were recouped in 11 months or less. Many bond experts feel that we are not just in a cyclical bond bear market, but have set sail for a secular bear market environment. The last secular bear market lasted from October 1941 to August 1981, when the yield on the fi ve-year treasury went from 0.51% in October 1941 to 16.36% in August 1981, according to research from American Century Investments. We went back and looked at the yields from the 10-year treasury constant maturity index and returns for the 10-year treasury

WHAT A YEAR FOR THE U.S. STOCKMARKETS!Investors, advisors, 401(k) participants, analysts, fi nancial media people, and just about anyone who was invested in a portfolio with U.S. stock exposure have to feel pretty good with the way the indexes ended up for 2013. With the U.S. economy still exhibiting stunted GDP growth in 2013, the major domestic indexes surprised with stellar returns. These stellar returns were somewhat muted by diversifi cation, but even the diversifi ed portfolios fared well, all things considered. In this issue of Market View we will take a look back at the market returns for 2013 and revisit the bond bear market which has already begun, and we will polish off the crystal ball and take a look at what REDW Stanley thinks is to come over the next year.

MARKET INDEXES POSTED VERY GOOD RETURNSLet us start by looking at the returns on the major market indexes. Just as in previous years, there were issues which concerned investors that manifested themselves throughout the year, but the U.S. markets were resilient and brushed off any negative news to post very good returns. As a matter of fact, it was a record-breaking year for some of the indexes. The Dow Jones industrial average posted its best return since 1995, rising 72.37 points to 16,576.66. The Dow fi nished the year up 26.5%. It punctuated the year end by closing out the year with its 52nd record close of the year. Maybe even more impressive is that it closed out the year 10,000 points above its 2009 bear market low of 10,030. The S&P 500 had its best year since 1997 with a gain of 29.6%. It also fi nished the year with a new record—its 45th record close of the year. The NASDAQ composite, a tech-dominated index, was the biggest winner of 2013, posting a gain of 38.3%. Not a record, but its seventh largest gain ever and its best performance since 2009 when it rebounded from its bear-market low.

After A Surprising Year, What Does The Crystal Ball Portend?

February 2014

By Jude V. Gleason, CFP®, AIF®, MBA - Chief Investment Offi cer

technical factors such as supply and demand factors within the economy and bond sectors, as well as the pace and magnitude of yield changes and credit risk, can also impact bond returns. Based on these factors and additional analysis, we at REDW Stanley believe that the bond bear market will not be severe and the eventual increase of yields and interest rates toward their historical averages are positives for the markets and the economies of both the U.S. and the rest of the world.

REDW STANLEY’S TAKE ON 2014Based on the aforementioned analysis of bonds, how do we see 2014 playing out? While we do not expect bonds to exhibit extreme downside behavior, we do acknowledge that bond returns will more than likely be negative. We see this as an opportunity for U.S. domestic stocks to have another good year. The domestic markets will be hard-pressed to duplicate last year’s returns, but based on our view of bonds and our analysis of the fundamentals, we see both the domestic stock markets and the international developed markets benefi tting from rising bond yields along with improved economic growth. REDW Stanley continues to preach that fundamentals move the markets in the long-term, so let us take a look at the 2013 year-end fundamentals. The forward P/E (price-to-Earnings ratio) is 15.4 versus the 15-year average forward P/E of 16.2. The P/B (Price-to-Book) is 2.7 versus the 15-year average of 2.9. P/CF (Price-to-Cash Flow) is slightly below the 15-year average at 10.6 versus the 15-year average of 10.8 while P/S (Price-to-Sales) is just above the 15-year average at 1.6 versus 1.5. The PEG which compares the Price/Earnings to the expected Growth rate is 1.5 versus the 15-year average of 1.6. Lastly, the Dividend Yield on the S&P 500 is 2.1% versus the 15-year average of 1.9. Based on this data it appears that, fundamentally, we are close to or at fair value on every factor—so why would we expect the markets to continue to move higher? Our reasoning is best explained through an analogy. The analogy that seems to represent the movements of the fundamentals best is that of a pendulum. The pendulum swings from one extreme to the other and never stops at the mid-point. It follows the current trend all the way until it reaches the extreme of the direction in which it is heading. So, when the markets are trending lower after having run up to become overvalued, the pendulum tends to bypass fair value and swings all the way back to become undervalued. Since the great recession of 2008, when the markets became undervalued, over the last fi ve years they have been moving toward fair value. Having reached that plateau, we expect that they will continue on until they reach an overvalued state and the pendulum begins its trek back in the other direction once again.

from April 1953 to January 1982. During this period, yields for the 10-year treasury went from 2.83% to 14.59%. We didn’t go all the way back to 1941 because the yield information obtained from the Federal Reserve website only goes back to April of 1953, and we used the 10-year treasury because once again, information was readily available for the 10-year treasury versus the fi ve-year treasury. The fi ndings might surprise many investors. Over that 29-year period of the secular bond bear market, the 10-year treasury only had negative returns eight times; compare that to the S&P 500, which during that same period had nine negative years. The worst year for the 10-year treasury was 1969, when treasuries returned -5.01%. The very next year, 1970, saw the 10-year treasury soar with a 16.75% return. The S&P 500 had a worst case scenario of -25.90% in 1974 and followed up with a 37% return in 1975.

Of course, it’s not fair to compare stocks to bonds because they have very different risk profi les, serve very different purposes, and usually have very different risk/reward

expectations. What is common to both the stock markets and the bond markets, however, is that they both fl uctuate up and down in the short-term and have periods of negative returns, and if an investor is patient, they go up far more than they go down, and the returns are positive in the long-term based on historical data. Past returns are no guarantee of future returns, of course, but our strategy is founded on widely accepted investment principals and fundamentals give us a very good opportunity to be successful. The average annualized return for the 10-year treasury over that 29-year period we observed is 3.05%. While not a stellar return, that certainly is not bad for an extended bond bear market and a return that many bond investors would be very happy to have under current conditions. Another interesting fact is that there were only two periods in which the 10-year treasury had negative returns in back-to-back years: ‘55 – ‘56 and ‘58 – ‘59, with the worst of those four years posting a -2.65% return. The returns after both periods were 6.80% and 11.64% respectively, so even when there seems to be an extended period of negative returns, the bond market is quick to regain those losses.

There are numerous factors that can contribute to bond returns or the lack thereof, and yield fl uctuations are considered a major component of those returns, but

2

Deploying Corporate Cash

28%

30%

Corporate Cash as a % of Current AssetsS&P 500 companies – cash and cash equivalents, quarterly

Corporate Growth

Capital Expenditures M&A Activity $bn, nonfarm nonfinancial capex, quarterly value of deals completed

$1 400

$1,600

$1 600

$1,700

20%

22%

24%

26%

28%

Equi

ties

$600

$800

$1,000

$1,200

$1,400

$1,200

$1,300

$1,400

$1,500

$1,600

'00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '1314%

16%

18%

Cash Returned to ShareholdersDividend Payout Ratio

$0

$200

$400

$900

$1,000

$1,100

'00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13

50%

60%

y$bn, S&P 500 companies, rolling 4-quarter averagesS&P 500 companies, LTM

Dividends per Share

$100

$120

$140

$160

$27

$30

$33

20%

30%

40%

Share Buybacks$20

$40

$60

$80

$

$15

$18

$21

$24

13

'00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '1320%

Source: Standard & Poor’s, FRB, Bloomberg, FactSet, J.P. Morgan Securities, J.P. Morgan Asset Management. (Top left) Standard & Poor’s, FactSet, J.P. Morgan Asset Management. (Top right) M&A activity is the quarterly value of deals completed and capital expenditures are for nonfarm nonfinancial corporate business. (Bottom left) Standard & Poor’s, FactSet, J.P. Morgan Asset Management. (Bottom right) Standard & Poor’s, Compustat, FactSet, J.P. Morgan Asset Management. Guide to the Markets – U.S. Data are as of 12/31/13.

$$'00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12 '13

3

Last year was a really strong year for equity markets, while bonds did not do so well. Our evaluation of the current bond environment is that they won’t do so well this year either, but probably not quite as poorly as many investors expect. We believe that any losses in the bond portion of the portfolio will be recouped in the equity portion, as the disinterest in bonds, combined with improved growth as corporations use their cash reserves, along with the continued improvement of fundamentals, will send U.S. domestic equities and international developed markets higher.

As complicated as investing may sometimes appear, there are times when it is just simple and basic. Such is the case with the last reason we are going cite as to why we feel the markets are primed to head higher. Corporations are still sitting on an enormous amount of cash, and as companies use these cash holdings to invest in projects that will result in increased revenues, the earnings will increase and stock prices should increase along with those earnings. The chart on page three shows that corporations are hoarding nearly 30% of their current assets in the form of cash.

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REDW Stanley is a highly respected investment advisory fi rm with a primary focus on serving clients in the

Southwest. As fee-only advisors, we do not receive commissions or sell investment products, so you can be

confi dent that our recommendations and advice are based solely on your needs and with only your success in mind.

In Arizona, the fi rm operates under REDW Stanley Wealth Advisors, LLC, an SEC registered affi liate of REDW LLC. In

New Mexico, it operates under REDW Stanley Financial Advisors, an SEC registered fi rm subsidiary of REDW LLC.

Copyright 2013 REDW Stanley Financial Advisors, LLC. All Rights Reserved. This publication is intended for general

informational purposes only.

The information provided herein is for informational purposes only and should not be construed as investment,

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