01-06-2014

The ETF/No Load Fund Tracker

Monthly Review—December 31, 2013

US Equities End 2013 On A High; Dow Logs Biggest Gain In 18 Years

US stocks finished 2013 with a bang with the Dow Industrial Average and the S&P 500 ending the year on a record high, making sure blue chips logged their biggest annual gains since 1995.

The financial markets have been trying to front-run the US Fed around the timing and scale of tapering since the central bank first announced its intention in May and that has been the dominant theme for the markets for the rest of 2013. Equities witnessed fleeting anxious moments and bond yields surged on expectations of an imminent interest rate hike.

By the time the Fed set the ball rolling and announced in December a $10 billion reduction in asset purchases starting January 2014, markets had reconciled to the fact that a rate hike is nowhere on the horizon as the central bank pledged to keep the target Fed Funds Rate near its current levels well after the unemployment rate had fallen below 6.5 percent.

The Fed’s dovish forward guidance boosted the bond market with Treasuries nearly retracing all of their post-announcement losses. Although many market participants remain worried about a pullback they say is long overdue, equities may play out flat in January.

However, markets generally perform well in the January-May period, partly due to additional flows into retirement accounts. Also, fourth-quarter earnings are likely to exceed expectations, ensuring equities hold ground at current levels.

On the macro-economic front, data continued to be mixed in December with job creation and GDP growth continuing with their positive momentum, paving the way for higher capital spending as we go along. Data released by the Conference Board revealed the consumer confidence index advanced to 78.2 in December from a revised 72 in November.

While consumers seem to feel more optimistic after politicians made truce in Washington and the Senate passed a two-year budget agreement, eventually, an elevated confidence level will have to be supported by sustainable income growth and a robust labor market once the current euphoria has died.

The housing sector continued to mend in 2013, maintaining its overall growth momentum. The Case-Shiller home-price index for October rose 0.2 percent, indicating sustained demand.

Initial jobless benefit claims declined by 2,000 to 339,000 in the week ending December 28, the Labor Department said. Continuing claims, which shows the number of people already receiving unemployment benefits, fell by 98,000 to a seasonally adjusted 2.83 million.

The US labor market continues to heal as hiring by companies appears to pick up. The private sector added 191,000 jobs on an average through the first 11 months of 2013, the most since the economic contraction ended in mid-2009.

On the flip side, the Chicago Business Barometer, a regional gauge of business activity, dropped to 59.1 percent in December from 63 percent in the prior month. Though the decline was steeper than economists’ forecast of 61 percent, it remained above the 50 percent mark that suggests expansion.

Inflation continued to remain benign with PPI falling 0.1 percent in November. Core producer prices, which exclude volatile items, rose 0.1 for the month. Both readings matched forecasts.

The strong growth in third-quarter GDP also failed to cheer as latest data showed change in inventories accounted for 1.68% growth in economic output. The bigger-than-estimated inventory build-up is likely to be a big drag on the economy. The consensus estimate puts fourth-quarter GDP growth at less than 1 percent.

European stocks closely followed US equities in 2013. The pan-European Stoxx Europe 600 index finished the year up 17.3 percent. Among the regional indices, Germany’s DAX 30 index zoomed more than 25 percent in 2013, making it the best-performing European regional index among the major economies.

The French CAC 40 index added nearly 18 percent in 2013 while the British FTSE 100 index picked up 14 percent.

Smart money seems to agree European equities will outperform the US in 2014. A poll by Bank of America Merrill Lynch showed 43 percent of fund managers were overweight on Europe compared to just seven percent for the US.

Looking at the big picture, the major trend direction, as measured by my Domestic Trend Tracking Index (TTI) remains up, as the chart below shows:

TTI123113

The index itself (green line) still hovers above the trend line (red) by a solid +4.34% indicating strong upward momentum.

Our core holdings showed good results during 2013, although, with the benefit of hindsight, it became clear that the early leaders finished the year on the weak side. Here’s the annual comparison of our major ETF holdings:

YTDETFs

As you can see, consumer staples (XLP), green line in chart, came out like gangbusters and made its returns during the first 5 months, while the discretionary consumer section (XLY) had a slow start but a breathtaking second half of the year. All others were somewhere in between.

With XLP showing a disappointing finish, I have started to reduce our exposure to it and added some of the better performers. Most important, however, continues to be my theme that, despite the current positive economic numbers, this rally can be unraveled by a number of global events, which means that the use of our exit strategy becomes even more important as the market’s rise was predominantly caused by an accommodating Fed policy.

I’ll be on the lookout for any trend changes but, for right now, we will enjoy the ride as long as it lasts.

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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