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Monthly Market Update - December 2014

January 22, 2015

December was a somewhat weak month for markets, but the year overall resulted in positive returns for investors with diversified portfolios. The S&P 500 Index posted its third straight year of double-digit gains. For the month the index was relatively flat (-0.3%) and was outperformed by small-cap stocks (Russell 2000 Index) which returned 2.9%. Economic data was largely positive, and the unemployment rate ticked down to a fresh five-year low of 5.6%. Inflation (CPI) for the month was negative at -0.3%, and consumer confidence rose to a new high of 92.6. International large stocks returned a disappointing -3.5%, but international small stocks fared better with a 0.8% decline. In better news, international bonds yielded strong returns for the month (+1.2%) and returned nearly 10% for the year. Inflation-protected bonds were negative (-1.1%), and intermediate-term bonds returned -0.3%. REITs dominated 2014 with a return of 22.8% for the year after rising 0.8% in December. Commodities started the year off strong but were crushed by the sharp decline in oil prices.

Economy

  • The final estimate of third quarter U.S. real GDP growth came in at 5.0%, well above the initial estimate of 3.5%.
  • Inflation (CPI) for the month of November was negative at -0.3%. Year-over-year inflation fell to 1.3%.
  • Broad-based job gains brought unemployment down to 5.6%.

Stocks

  • The S&P 500 Index returned -0.3% for the month and 13.7% for the year making it the third consecutive year of double-digit returns.
  • Developed international large cap stocks returned -3.5%, and emerging market stocks declined 4.6%.

Bonds

  • International bonds returned 1.2% for the month and were the strongest bond segment in 2014 with a return of 9.9%.
  • Intermediate-term bonds declined 0.3%, and TIPS fell 1.1%.
  • The 10-Year Treasury yield fell from 3.0% to 2.2% in 2014.

Alternatives

  • REITs gained 0.8% for the month and 22.8% in 2014.
  • Commodities fell 7.6%, attributable to the continued freefall in oil prices.

Commodities In the Red - What Now?

Gas and oil prices have been a hot topic as of late – and for good reason! Oil prices peaked in June 2014 at $107 per barrel before falling to current levels near $50 per barrel. The explanation, of course, is more supply and less demand. While the U.S. economy remains strong, weak economies in Asia and Europe have lowered global demand for oil. On the other side of the equation, the U.S. has expanded oil production rapidly in response to the previously higher prices, increasing supply. Many large oil exporting countries are further driving down the price by not cutting production in response to the lower demand. What happens with the price of oil will depend on if and when production is adjusted and if any changes in consumption take place due to the low oil prices.

As a result, commodities haven’t exactly been the bright spot in investors’ portfolios. But there are some important things to keep in mind:

  • Such large drops in commodities are rare. The S&P GSCI Commodity Index dropped 33.1% in 2014 making it only the fifth calendar year since 1970 with a drop of more than 20%. And when that has happened, the subsequent one to two years of performance were typically strong.
  • Investors may be looking to reduce their commodity exposure after such a large drop, but we know that large declines are typically coupled with overreactions. Maintaining the current commodity allocation allows the investor to retain the potential upside.
  • Commodities are typically only a small portion of portfolios, but their low correlation with equities makes them a great diversifier. Also, the benefits of lower energy costs for consumers and businesses should help stimulate the economy going forward and be an overall positive for the stock market.

Sources: Bureau of Economic Analysis (BEA), Federal Reserve, Institute for Supply Management, JP Morgan, Morningstar Direct, Standard and Poor's, Wells Fargo, Yahoo! Finance, BofA Merrill Lynch

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  • Monthly Market Update - December 2014