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Five New Year's Resolutions for Investors

Fri, 3 Jan 2014

After a strong 2013, investors should vow to keep expectations in check, avoid complacency over Europe, and tune out the noise from D.C., says Morningstar markets editor Jeremy Glaser.


Video Transcript

Jason Stipp: I'm Jason Stipp for Morningstar, and welcome to The Friday Five.

We just wrapped up a stellar year in the stock market, and as we look forward to 2014, Morningstar markets editor Jeremy Glaser has a few sensible resolutions for investors. He's joining me today.

Thanks for being here, Jeremy.

Jeremy Glaser: You're welcome, Jason.

Stipp: Your first resolution is, after that great year we had in 2013, you say, take a deep breath and maybe hold on.

Glaser: It could very well be a bumpy year in 2014, and this is in no way any kind of short-term market prediction. We just don't know what's going to happen over the next 12 months. But I think it's safe to say that another 30% return seems very unlikely for a few reasons.

First is just where valuations are. After that big, multi-year runup, valuations are pretty stretched, depending on how you want to look at it. Our equity analysts generally think that we're a little bit overvalued right now on average, and there are just a few pockets of value left. Some areas look quite a bit overvalued. There just isn't that much room for a lot of growth unless we're going to see the market become very overvalued, which is a possibility.

Earnings growth, although OK, is certainly not stellar. You don't see that kind of earnings growth really supporting big changes in the market. With interest rates going up, that also has a potential to really put a damper on what's happening with the stock market in 2014.

But all of those things are volatile, and that could lead to a lot of volatility [in stock prices]. When you're at these full valuations, if things don't turn out exactly like the market is expecting right now--say, the taper happens a little bit faster, interest rates rise a little bit faster, earnings don't look as good, economic growth doesn't look as good--you could see some pretty big swings. I think investors need to be prepared for that, and keep that in context of the fact that we are at this fully valued place in the market.

[Investors] need to be thinking about the long term. Not what 2014 or 2015 returns are going to look like, but what does the next 10, 15, 20 years look like? I think the risk-return still is in investors' favor over that long horizon, even if there are some factors that could give us a little bit of bumpiness in the short to medium term.

Stipp: Your second resolution, I think, will be difficult unless you move into a cave, but that's tune out the mid-term elections. Why would you say that for investors?

Glaser: I was hoping to maybe turn off my home Internet service and throw the TV out in order to try to get rid of what I'm sure is going to be a huge runup in terms to the 2014 midterm elections, and we're already talking about the 2016 presidential elections.

I think most investors really need to look at it as political theater. If you're interested in politics, be interested in it, but don't let it dictate a lot of what you're going to be doing in your portfolios and the way that you think about investing in businesses over the long haul.

With this budget deal in place, we probably won't have the kind of brinksmanship leading up to the election in terms of government shutdowns or the debt ceiling debates or the issues that have really plagued Washington for the last couple of years. Those seem much less likely to happen in 2014.

There will be plenty of rhetoric on both sides of the aisle about what will happen if the chambers switch sides one way or another. I think for the most part, there isn't going to be that big of a change. Even if the Republicans were to take over the Senate, which is a distinct possibility in 2014, with President Obama still in the White House, there won't be any major changes, as he would veto things like repealing the Affordable Care Act or things that actually could potentially have an impact on investors, or big changes to the tax code. I think for the most part, it will be a lot of noise and fury signifying nothing for most investors.

Stipp: Resolution number three, watch out for bad M&A. Why would we see more M&A and what does bad M&A look like?

Glaser: 2014 could be an interesting one on the mergers-and-acquisitions front. There are a couple factors that that could lead to more companies looking at deals. The first is that valuations are pretty high. When share prices are lofty, [and management] thinks [the stock is] maybe even worth more than what the company is worth, they could see that as an overvalued currency [to] spend on other companies. They could see that as an opportunistic time to look at deals, either public or private.

Also, the corporate debt market is still very much open, and rates--although rising a little bit--are still relatively low. We saw some huge corporate debt deals in 2013 with Verizon's purchase of the rest of Verizon Wireless, and Apple having a huge corporate debt issuance. It shows that those markets are definitely open, and that also gives some space for managers who are looking to do some of these deals to get that money in place.

But just because you have the money, doesn't necessarily make a deal a particularly good idea. I think we'll have to be very cautious if we see any of these big deals announced to make sure that they actually make strategic sense and aren't just being done because they can be done, or done for empire-building purposes, or that they're using a potentially inflated stock price to buy something that's even more inflated and destroying value for shareholders.

This hasn't been a major problem since the recession. Most management teams have been very prudent. They've been returning cash to shareholders through buybacks and dividends, but if we saw a surge in M&A, which is a potential in 2014, investors should be a little bit skeptical and really think through the deal and the valuation when assessing if it still makes sense for them to own those shares over the long term.

Stipp: Resolution number four is, keep an eye on employment data. Of course, employment data is an excellent indicator for the economy, but that's not the only reason that you would be watching employment data next year.

Glaser: Employment data is always important, but particularly this year, it's going to be even more important, because the Fed is so focused on what's happening with the labor market in making its decisions about how fast the taper is going to happen until we get rid of QE3 completely, and then eventually when short-term rates are going to start rising.

They are keyed into what's happening with the labor market, and if we see things continue to improve there, that's a sign that the economy is doing better, but we also need to think about what the implications are at the central bank. Particularly, it seems that even though the Fed has an inflation target, that given where inflation has been--that it's so low and there are no expectations that it's going to rise quickly--that's not going to be a major factor weighing against it.

Bob Johnson, our director of economic analysis, thinks we're going to have more of the same--around 190,000 jobs added a month--for 2014, like we saw in 2013. That could mean an unemployment rate, he thinks, between 6.2% and 6.5%, which is around the range where the Fed is going to be thinking about making some changes. That could potentially be a huge storyline in 2014 and one that people need to be keeping a close eye on.

Stipp: Last resolution: Don't get complacent about Europe. Europe has not been in the headlines recently at least, but you're saying, I can't let my guard down.

Glaser: I don't think you should yet. 2013 was a relatively quiet year, particularly with the German elections, which were essentially a non-event; the electorate was not upset with the way that [Chancellor Angela] Merkel had been handling the crisis so far. Generally there was a lot of behind-the-scenes work in trying to piece together what some of these long-term structural reforms look like in order to create a banking union and to get some more fiscal unity around the monetary union.

But there really hasn't been much success there. There are still a lot of fault lines about exactly how much interdependency there should be between these fiscal systems. How do you take care of bank resolutions? How do you make the banks raise more capital? What's a prudent way to make all that happen? These are questions that really do need to be answered, or we could see these little short-term crises pop up, and we just don't know exactly how many more of those can pop up before we get some sort of bad outcome. Cyprus was an example of something that most people did not see coming. It … briefly looked like it was something that could've had an impact across the world.

This is not to say that there is a high probability of any sort of major euro crisis in 2014. It's much lower now than it was a few years ago, but that still doesn't mean that we should completely put it out of our heads. Europe is still growing at an incredibly low rate. They still have these underlying competitiveness issues, and until all of that is resolved, we could see a lot of bumpiness from across the pond.

Stipp: Jeremy, I'll resolve to meet you here every Friday in 2014 for The Friday Five. Thanks for joining me again.

Glaser: You're welcome, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.

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