2014 Market Review: What Do We Know?

If you pay close enough attention to the news media you'll eventually learn that much emphasis is placed on pundits' forecasts, but very little consideration is given to how accurate the projections turn out. When 2014 started, there were some pretty widely-accepted expectations regarding the investment environment. Let’s take a minute to review those anticipations and analyze how precise they turned out to be.

One of the most universally accepted beliefs going into 2014 was that interest rates were on the cusp of rising, and that consequently, bond returns would drop. (Of course, this has been the expectation for around five years now, but that is a discussion for a later time.) Investors were questioning whether they should reduce or eliminate the bond portion of their portfolios until the rate increase occurred.

So have we experienced the rise in interest rates we were expecting? On 1/2/14, the yield on the 10-year Treasury note was 3%. As of 6/30/14, the yield on the same note was 2.516%. That's right -- interest rates have actually decreased over the last six months. Did those who stuck with their investment strategies and maintained their bond positions experience a decline in their portfolio's value? Here is how a variation of different bonds have performed year-to-date (as of 6/30/14):

• US Government Bonds (IEF): 4.89%
• US TIPS (TIP): 5.25%
• Corporate Bonds (LQD): 5.37%
• International Bonds (IGOV): 5.66%
• Emerging Market Bonds (LEMB): 6.42%

How about the equities side of the portfolio? In January, predictions for stocks were all over the map -- some predicted a full out correction (a loss of more than -20%), some predicted that we would keep chugging along at 2013's pace, and most predicted something somewhere in between. There were, however, many factors that were a common cause of concern.

The most widely accept fear among equity investors was the phasing out of the Fed's Quantitative Easing (QE) program. Investors worried that the Fed would begin lowering the amount of loans the government would buy from commercial banks each month, which would lower the availability of capital in the economy. Historically, less money in the system leads to less investing in new businesses, less innovation, and fewer jobs created.

So was the reduction of the Fed's Quantitative Easing a legitimate fear? In fact, this possibility has come to fruition. In December, the Fed was buying $85 billion per month of financial assets from commercial banks and other private institutions. The Fed has reduced this monthly amount during every meeting it has held this year, and that amount is now down to $35 billion per month. However, the key question is what impact has this had on the stock market. Here is how a wide basket of equities have performed year-to-date (as of 6/30/14):

• Large Cap Stocks (IVV): 7.08%
• Mid Cap Stocks (IJH): 7.57%
• Small Cap Stocks (IJR): 3.30%
• Foreign Stocks (IEFA): 4.34%
• Emerging Markets (IEMG): 4.70%
• Real Estate (IYR): 16.09%
• Commodities (DJP): 7.32%
• Gold (GLD): 10.27%

The last widely-held viewpoint at the beginning of the year was that 2014 was likely to be a year more volatile than anything we had experience in 2012 or 2013. There was a lot of clatter about valuations and PE ratios being too high, concern about the war in Ukraine, a consensus that China was about to experience a drastic decline in both imports and exports, and a general feeling that the market was due for a significant (if not healthy) pullback. Additionally, how much have we heard about unfavorable weather patterns over the last six months?

So has 2014 been a wild ride? The S&P 500 dropped by -5.51% from 1/22/14 - 2/03/14, and by -3.89% from 4/2/14 - 4/11/14. These are the only declines of more than 2% that the S&P 500 has experienced all year! Additionally, as of 6/30/14, the S&P 500 has now gone 54 consecutive trading days without an up or down move of greater than 1%, the longest stretch since 1995! By historical standards, 2014 is considered to be a very smooth ride.

The most significant lesson inherent in these numbers is that market expectations are essentially useless. Near the beginning of the year, the vast majority of experts anticipated interest rates to rise, bond values to drop, and volatility to increase. Unfortunately, pundits making projections are rarely held to their inaccurate forecasts and are allowed to continue making a living showing they have no greater knowledge than the average investor.

Of course, this is not to say that interest rates will never rise, that bond values will never decline, and that the market won't return to the roller coaster it is. In fact, all those things are certain to happen. Unfortunately, anyone who contends to know the uncertain part of this equation -- when -- likely doesn't actually know anymore than you or me. For this reason, having and sticking to a diversified investment strategy that coincides with a detailed financial plan is the most likely path to financial success.