It was a very strong year for U.S. stocks, fueled in large part by the Federal Reserve’s ongoing support and by improvement in the economic outlook. While developed international stocks also generated strong gains, emerging markets asset classes were strikingly negative as investors reacted to softer economic growth and potential changes in U.S. monetary policy.
Interest rates rose considerably over the course of 2013, as the yield on the 10-year Treasury jumped from 1.8% to just over 3.0% by year-end.
While it strikes us that the underpinnings of our economy are getting stronger, we also see that most asset classes are currently priced for just fair or subpar longer-term returns, and stock market sentiment in the United States is reaching optimistic extremes, suggesting a pull-back may be close at hand. Furthermore, the risks related to excessive global debt, subpar growth, and unprecedented government policy that we have worried about since the aftermath of the 2008 financial crisis still remain largely unresolved.
We don’t know the timing, but we are confident better investment opportunities will arise over the next few years. If so, our “dry powder” in the form of lower-risk investments in fixed-income and alternative strategies will be a major benefit to the portfolios instead of the drag on returns they were in 2013. We will continue to apply our discipline in order to capitalize on compelling return opportunities when they arise, but always with a strong focus on the risks to which our portfolios may be exposed, understanding that not all risks will ultimately come to pass.