2013’s Top 10 Lessons for Investors

Each year that passes contains some wisdom for investors, but along with that wisdom can be some folly. 2013 was a year that bestowed an abundance of each on investors.

The top 10 lessons of 2013 for investors need to be put into two categories: those that investors can take to heart as sound wisdom for the year to come, and those they should try to forget as they prepare for 2014.

Lessons investors can take to heart for 2014:

 1. Bonds can lose money. After a 13-year streak of annual gains, the bond market measured by the Barclay’s Capital Aggregate Bond Index fell about 2% on a total return basis in 2013, as interest rates rose from their all-time low in 2012.

 2. Sentiment can matter more than fundamentals. Investors were willing to pay more for stocks, leading to a rise in the price-to-earnings ratio as they grew more confident in the durability of future growth. This brighter outlook drove most of the S&P 500 Index’s gain in 2013, not the mid-single-digit pace of earnings growth or lackluster 2% gross domestic product (GDP). This is not uncommon. Historically, stocks have posted the most consistent gains when GDP has been around 3%. When GDP for a quarter was within plus or minus a half of a percentage point of 3%, the S&P 500 has posted an average gain of 6.5% during that quarter — the highest of any 1% range in quarterly GDP and nearly triple the 2.4% gain when GDP was more than twice as strong.

3. Time heals all wounds. In fall 2013, the one-, three-, and five-year trailing returns for the stock market rose into the double digits, and money finally started flowing into U.S. stock funds after the five years of net outflows that followed the financial crisis.

4. Defensive stocks can lead the market higher. During the first four months of the year, the defensive sectors — those that are less economically sensitive and tend to fare better when growth is weakening such as utilities, telecommunications, consumer staples, and health care — led the overall market to double-digit gains. For the year as a whole, the defensive health care sector outperformed with a powerful gain of 39%, as measured by the S&P 500 Health Care Index. This was an unusually strong performance for a sector that tends only to be among the top-performing sectors in years when overall S&P 500 returns are low (2011) or negative (2008). While overall cyclical stocks generally fared the best, for parts of the year defensive stocks led the way up.

5. Annual returns are rarely average. The 27% gain in the S&P 500 Index (30% including dividends) in 2013 was well above the long-term average of 5% (10% including dividends). Historically, annual returns have only been in the 5 – 10% range in eight of the past 86 years

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