2013 Themes: Snakes and Ladders – Year End Review

At year-end, we review our economic themes for 2013.  We give ourselves 8 out of 10 points, for 7 themes that hit the mark, and two that were partially realized.  We were flat out wrong on one.

1. üEurope lingers: “…In our view, the European Union will have to provide financial assistance to one or more peripheral countries in 2013, we believe this may be delayed till after the German elections to limit the impact on the Merkel government.”  Cyprus did indeed receive an emergency bailout in 2013. The European crisis continues to be a concern and none of the peripheral European countries have as yet exited the bailout mechanisms put in place.  Spain, Greece, Romania, Cyprus, Portugal and Ireland all received funds in 2013.
2. ? Asia slowdown: “The biggest Asian economy is showing some growing pains… We believe China will underperform other emerging markets over the next year.” Chinese GDP growth is officially estimated at 7.6% for 2013, markedly lower than the double digit rates it has achieved in prior years.  The Shanghai composite’s total return for 2013 was 3.56%, while the Hang Seng was down 2.84%. Neither are stunning returns, but emerging markets performed poorly as a whole in 2013. The MSCI Emerging Markets index lost 4.9% and Brazil, Turkey and Indonesia all performed worse than China.
3. ûEquities: “…We believe… there is a strong probability that stocks will be in for a very rough ride… we believe stocks with strong balance sheets, robust business models and high-quality earnings will outperform.”  We were wrong on this call. Though the MSCI World Quality index returned 27.74%, MSCI Europe Quality index returned 21.52% and the S&P High Quality Index returned 32.44%, they were matched by the broader markets. The MSCI World returned 27.37%, the S&P 500 32.39% and MSCI Europe 25.96%.  Lower quality, speculative stocks have led recent market gains fueled by sustained quantitative easing.  Though there was some mid-year volatility, US stock markets saw a sustained rise in 2013.
4. üThe myth of hyper-inflation: “…the Federal Reserve has bought over two trillion dollars in Treasury and MBS debt over the past four years… When it begins to sell its bond holdings, vast amounts will be taken out of the money supply, putting a damper on any inflation. This is why we find inflation protected bonds relatively unattractive.” TIPS performed poorly in 2013, the Barclays US Treasury TIPS index lost 8.61% for the year. We see virtually no sign of inflation in the US at the moment and do not believe it is a concern for the immediate future.
5. üA rude awakening for bonds: “The Fed has been providing price support for long-dated bonds with its large purchase program and low interest rates. When that price support stops and the market has to stand on its own, we expect bond prices to collapse and rates to rise… we find long-dated bonds extremely risky and prefer floating rate, short-duration and international bonds.” Long term treasuries were a poor investment in 2013. The Barclays US Treasury 20+ year bond index lost 13.88% as yields on 30 year treasuries rose from 3.04% to 3.96%.
6. üThe Sun also rises in Japan: “…We see Japan’s demographics stabilizing and a generational change underway in Japanese business creating an entrepreneurial surge. We believe this presents an attractive opportunity for equity investors.” Though most of the market surge occurred in the first quarter, Japanese markets have held on to gains this year and the MSCI Japan index returned 27.16%, the best performance in many years.
7. üGold: “…We continue to hold that the price of gold is elevated beyond fundamentals and not sustainable. We see demographic changes that are steadily eroding Asian demand for gold, removing this long ranged support. We expect gold prices to drop in 2013.”  We were right here. Gold prices have dropped almost 28% in 2013, from over 1600 to 1170.
8. ? The death of the PC has been greatly exaggerated: “…Despite being overshadowed by its cooler, touch-sensitive cousins, the traditional computer remains the one device capable of performing the whole range of computing functions. It will remain an essential business tool for years to come. We think it’s a little too early to call the death of the computer, and that certain PC-related stocks will outperform in 2013.” PC sales are estimated to have dropped some 11% in 2013 to around 300 million, with tablet/smart-phone sales surging. That said, in some cases, PC stocks saw enormous gains in 2013 (HPQ 100.33%, MSFT 43.69%, DELL 39.02%, Lenovo 36.1%) even though smart-phones and tablets have continued to encroach on PC functionality.  So while the trend away from PCs continues, 2013 proved that many PC-related companies remain viable businesses.
9. üNetwork everything: “…Over the course of the next decade, we expect to see more devices linked to the broader Internet for specialized and general function. This will include cars and household appliances, opening up new use cases and opportunities for businesses positioned to produce the right set of products and services. We believe the technology sector in general, and Internet infrastructure firms in particular, offer attractive growth potential over the next decade.” We continue to see upticks in the number of devices connected to the Internet and though it is still early for this prediction, the S&P North American Technology Index return 34.57% in 2013, outpacing the S&P 500 and MSCI World.
10. üAlternative Energy: “…Alternative energy at utility scale is approaching cost parity with conventional energy generation, and a nascent environmental movement is developing in the emerging world. These two trends are changing the equation for alternative energy and 2013 should see an increase in investment flows towards non-conventional sources of energy. We think prices are relatively depressed and the sector offers attractive value for long-term investors.” Alternative Energy did indeed make a strong comeback in 2013 and more attention is being focused on the industry. The S&P Global Clean Energy Index returned 48.42% for the year and the Nasdaq Clean Edge Green Energy Index returned 89.34%.