The other night I had the pleasure of watching my two favorite college basketball teams win. There was a time when that was not unusual, but the last few years have been tough for my Wake Forest Demon Deacons. As a Wake alum, the Deacons are of course my favorite team. My second favorite team is whoever is playing Duke, and this week that was Notre Dame. Wake successfully vanquished the Carolina Tarheels while the Fighting Irish took care of those Blue Devils for us.
At the halftime break a reporter grabbed Wake’s coach, Jeff Bzdelik, to get a few words. Bzdelik said he was happy with Wake’s rebounding. The announcers, and everyone else watching, was left wondering what he was talking about. Carolina was killing Wake on the boards and had a huge lead in rebounds, even though it wasn’t helping them much on the scoreboard. It reminded me that things aren’t always what they seem when you are actually going through them. I’m sure when Bzdelik looked at the actual statistics his opinion changed, but watching it from his perspective in real time things looked different. It happens to all of us. This is one of the reasons keeping statistics can be so helpful.
Take 2013 for example: I think if you asked most people about 2013 they would say it was a wonderful year in the stock market, but a horrible year from a political or public policy stand point. But was it? At the beginning of 2013 we were facing a fiscal cliff, a sequester and the debt ceiling. The consensus among economists was that our debt situation required a combination of tax increases and spending cuts. There was also a consensus that it would never happen because one party refused to cut spending while the other refused to raise taxes. But it did happen. Yes it was ugly – very ugly – and far from perfect. No one is happy because no one got their way. However, we are in better shape fiscally today then we were 365 days ago, and that improvement is progress. Mild perhaps, but progress nonetheless. That progress is not acknowledged, but it is part of why the economy is improving slowly but surely.
That improvement has in part spurred the bull market. The year in stocks, however, is more complicated than it might seem on the surface. I say it all the time, but what is happening beneath the surface of the broad indices is much more meaningful than just the return of the index. What looked like a straight line bull market all year was really two very different halves. The first half of 2013 was all about junk; half way through the year the best place to have been within the S&P 500 was the 50 companies with the worst analyst ratings. That was unsustainable. We had a mini-correction in August and then began a rotation. The second half of the year quality once again mattered, and that is an encouraging sign in our opinion.
For two and a half years or so fundamentals and valuation seemed to not matter as the market was so focused on one political crisis after another – domestically and in Europe – instead of what was really happening at the company level. A recent article on Bloomberg.com noted that Warren Buffett has underperformed over this period. That isn’t surprising because almost everyone who pays attention and tries to act rationally has been in the same boat. But these periods never last. Eventually reality wins out and fundamentals are recognized. It appears that transition began in the second half of 2013.
That makes us optimistic about the beginning of 2014. Markets don’t go up in straight lines, and after a 10 percent quarter we wouldn’t be surprised by some consolidation. There is certainly some over-priced junk left from the bull run in 2013, but there are also some quality companies out there with decent valuations. 2014 could be a good year, particularly for the prudent investor.
Happy New Year, and Go Deacs!
Chuck Osborne, CFA
Managing Director
