Did January set the tone for 2014?

Many investors were spoiled by the stock market returns of last year, so the rough start for 2014 might have caused some unease that financial advisers should address with clients, some of whom likely remember the old adage: “As goes January, so goes the year.” At the very least, the rocky start gives advisers an opportunity to touch base with clients and address any concerns they might have. With the market down more than 3% for the month of Janary, investors might be thinking that it is time to take some profits before a correction takes away all or most of the gains from last year. Despite the January decline, the S&P 500 is still up more than 18% for the 12-month period.

NO SURPRISE

A temporary correction isn't unexpected. Last year, the stock market, as measured by the S&P 500, delivered a return — including dividends — of more than 30%, while corporate earnings, when final figures are tallied, likely grew by only about 7.5% and the economy by only about 2%. This implies rapid expansion of the price-earnings ratio. By Yale University professor Robert Shiller's cyclically adjusted calculation, which averages profits over 10 years, the P/E for the market at the end of the year was 25.4, well above the historical average. The ratio can move back toward the average through a market correction, by stock prices increasing more slowly than corporate earnings or by more-rapid earnings growth. The last would be preferred. Perhaps investors were calculating their P/Es based on estimated 2014 earnings, which would lower the ratio if they expected those earnings to be higher than those of 2013, but many analysts have been reducing their 2014 earnings estimates. As noted in a previous editorial, a year of strong market gains more often than not has been followed by another year of gains, though of much smaller magnitude, so a down year won't necessarily follow 2013's strong market. But this year is likely to be bumpier than 2013, with the Federal Reserve having embarked on tapering its bond purchases, and China and some emerging markets showing some economic weakness. Clients are likely to need more hand-holding from advisers, and it isn't too soon to begin.