2014 Themes: Use Extreme Caution

Dear Friends,

We’d like to start off by wishing you a very happy and healthy 2014. We trust you enjoyed the holiday break with family and friends.

At the beginning of each year, we put together a list of our top 10 investment themes and predictions for the year ahead.  We’ve done this now for four years, and our fifth installment is enclosed. We hope our perspective helps inform your view of the current and future investment climate.

We’ve also graded ourselves on our 2013 themes: we were wrong on one, right on seven, and are giving ourselves half a point for two. Eight out of ten is a very good score in the investment world. However, our celebration is tempered by the fact that we were rather wrong on our call for equities. Developed market stocks performed very, very well in 2013 with the US leading other markets.

That has not deterred us from applying our value methodology to equities in looking forward. We continue to caution investors to be wary of US stock prices which are currently rather high.  For most investors, we would recommend a moderate underweight towards stocks in their portfolio, but there are other ways to implement a cautious view towards equities.

The New Year also brings with it an opportunity to make decisions on certain tax and retirement plan issues. We encourage clients to think about the following, and we are happy to discuss them in more detail:

• If you haven’t already, this may be a good time to put together a household budget for 2014.
• Review your 401k contributions for 2014 to confirm you’re saving enough for retirement.
• You have until tax day to make a 2013 contribution to an IRA. The limit for 2013 is $5,500 ($6,500 if you’re over 50).
• If your financial plan is at least two years old it may be time to revisit it along with your will, life insurance and other long-term financial documents.

We hope you have a chance to review our themes for 2014. We look forward to speaking with you to review your accounts for the start of the year and we’d be pleased to address any other questions you might have.

Regards,

 

Louis Berger                                                                                        Subir Grewal

 

 

1. The bond decline continues: 2013 was not a good year for bonds, particularly longer term (20+ year) bonds which saw double digit losses.  With the Fed’s announcement that “tapering” (aka stimulus removal) will begin in January, market participants should brace for higher rates/yields and lower bond prices.  While we don’t foresee a rapid rise in rates (the Fed should be able to prevent a shock), we think the trend will continue.  The 20 year treasury began 2013 at 2.63% and ended the year at 3.70%.  We wouldn’t be surprised to see it exceed 4.50% by the end of 2014.  If it approaches 5%, we think it would provide a good entry point for investors to begin taking positions in longer dated bonds (10+ year maturities) again.
2. Equities: Last Call at the QE punchbowl: The US and global equities rally has been underway for almost five years now and US indices have roared back, setting all time record highs in 2013.  As most market participants know, the economy, while improving has not done most of the heavy lifting.  Stocks and earnings have benefitted most by the easy money/stimulus policies of the Fed.  Ben Bernanke’s era as Fed Chairman has come to a close, but not before a pre-announced reversal in policy as the Fed attempts to unwind their QE program.  This will likely cause interest rates to rise which will create a tougher earnings climate and contracting PE (Price-Earnings) multiples for most companies.  These will put a lot of pressure on stock prices.  With multiples at cyclical highs, conditions are ripe for a significant correction, especially in US markets. We advise investors to avoid complacency and prepare for a potential 20%+ correction in 2014.
3. Bitcoins backlash: 2013 saw the “virtual currency” bitcoin garner a great deal of interest, and publicly-announced investments from some high-profile personalities. In our view, bitcoins are no different from tulips in Amsterdam during the early 17^th century.  They are the latest incarnation of speculative manias that invariably end in tears.  What sets bitcoins apart from the South Sea Bubble, Railroad mania, Florida Real-Estate and even Tulip Mania, is that the speculative premise is even more unlikely than all prior episodes.  Bitcoins are generated expending the same sort of worthless effort that gold miners do when mining gold from underground veins, refining it and storing it back in underground vaults. The entire process adds no value to human life except for those amongst us who gain intrinsic satisfaction from knowing some dull, heavy, yellow metal is being held on our behalf. Perhaps the one thing we can say about bitcoins is that mining them does not result in the terrible environmental impact that mining gold does. Despite the concerted efforts of many conspiracy theorists, we do not see a major reckoning for fiat currencies in the offing and therefore continue to caution against allocations to alternative or commodity based currencies.
4. Social Media Mania: 2013 has seen a handful of very high profile IPOs from social media companies.  Some of these companies have minimal revenues and in many cases no prospect of increasing them without significantly degrading the user experience.  Numerous companies are trading at stratospheric P-Es above 200. We are long-term believers in the transformative potential of technology, but do not believe current valuations are anywhere near reasonable. Investors will have to be a lot more selective in 2014 if they are to avoid the kind of fall we saw in the early 2000s. We expect to see several of these high-flying tech IPO darlings come back to earth this year.
5. Go Global or Go Home: One of the defining characteristics of the telecommunications revolution of the past two decades is that the world has never been closer.  For the first time in history, a large portion of the human population, particularly the elite, richest sliver, consumes the same media. Baywatch was the first globally syndicated show watched across the world for its universal appeal and it first aired 25 years ago. For US investors, this globalization represents an opportunity since the world is largely consuming American media (particularly when it comes to children’s entertainment). We believe media companies with strong properties are on the cusp of another period of growth in market-share. At reasonable valuations, they represent an attractive long-term investment.  At the same time, we believe strong regional, cultural media properties will also find traction in their home markets and any areas with affinity.
6. Commodities Wane: Commodities, for the most part, have been in a relatively flat holding pattern since the 2008 bubble.  We expect commodity prices to remain weak or stagnant throughout 2014. We do not anticipate large rises in economic activity in the offing, which means commodity prices will remain depressed.  We do not expect gold or other precious metals to recover and anticipate further declines.
7. Wages and Profit: The past few years have seen corporate earnings rise while average wage income has stagnated along with labor costs as a portion of GDP. We expect 2014 to reverse some of this trend as a declining unemployment rate and an evolving political climate make for higher wages and a higher minimum wage floor. We believe this will put pressure on industries and companies that rely on a large, low-paid work-force.
8. Health-Care Strengthens: Gains in the Health-Care Index have outpaced that in the broader markets by about 10% in 2013. 2014 is the first year the impact of the Affordable Care Act will be felt in revenues of insurers and health-care providers.  We expect health-care revenues will rise and the sector will continue to outperform the broader market this year as well.
9. Atlantic tug of war: The Euro has appreciated against the Dollar over the course of 2013, as the European fiscal crisis has been pushed off center stage.  We believe the Fed’s tapering will reverse this move and we will begin to see the dollar appreciate as rates rise in the US.
10. Water Works:  We have been concerned about water-related infrastructure for a number of years. Most population growth is occurring in regions with limited access to large quantities of fresh water and this problem is more acute than any issues with power generation. We believe consumers and regional planners have begun to appreciate this as well and we will see a rise in investments directed towards water infrastructure. Major engineering companies and water utilities should benefit, as will firms with consumer products that improve efficiency.