Sometimes the best investment advice is to do the opposite of what everyone else is doing.
When the stock market was in free fall during the financial crisis, many investors who had hung on for as long as they could take it finally gave up and sold their stocks, locking in huge losses and missing out on a historic rally.
Last summer, with the first hint that the Federal Reserve Board would be tapering its bond purchases, interest rates began to rise and investors sold bonds in record numbers. In many cases, investors moved more money into stocks, as the market continued to set records throughout 2013 after a brief drop that was fueled by taper talk. 
That’s proven to be a mistake, as bonds have so far outperformed stocks in 2014. In fact, 10-year Treasuries have outperformed the S&P 500 by about 620 basis points.
We’ve suggested that investors not give up on bonds and likewise suggested that gold may shine again, in spite of its tarnished 2013 performance. Recent trends suggest that it’s worth repeating this advice.
Stocks Moving Sideways
First, consider the current state of the U.S. stock market. Sideways may be healthy for storing a bottle of wine, but it’s not a good direction for the stock market, even though it’s better than a bear market.
The S&P 500 has spent most of this month trading in a range of 1815 to 1850. That’s better than a drop, but trading is not going to remain in that range indefinitely.
Some are hoping for a “sideways correction,” which isn’t a correction at all, but a correction in stock prices is more likely – especially given recent corporate earnings. This week, with 12% of the S&P 500 companies reporting fourth-quarter earnings, only 56% topped expectations, which is below the long-term average of 63%, while 32.8% have missed earnings forecasts, compared with the average of 21%.
Of course, the Fed has been the driver of market performance in recent years and that may continue in 2014. Additional tapering is expected, but if Chairman Ben Bernanke’s final action is to reduce bond buying from $75 billion to $65 billion a month, incoming Chairwoman Janet Yellen could very well reverse course, given recent lackluster economic performance.
Bond Prices Moving Up
Treasuries enjoyed their third consecutive week of gains, as yields dropped this week, and recent economic news could cause gains to continue.
The Fed has made it clear that interest rates will remain low for the foreseeable future, and mediocre economic news would reinforce that position. “Mediocre” may be optimistic, considering that:
- Fed Bank of Richmond President Jeffrey Lacker said he expects economic growth of 2% this year, which is less than the 2.8% median estimate reported in a Bloomberg News survey of economists.
- Housing starts declined in December.
- Industrial production slowed last month.
- Consumer confidence unexpectedly declined this month.
- The unemployment rate declined to 6.7%, but only because more Americans have stopped looking for work.
Gold Showing Signs of Recovery
Prices soared to record levels after the financial crisis began in 2007, but 2013 was not kind to gold. Prices dropped more than 25%, which was gold’s worse performance in more than three decades.
Analysts are making mixed predictions about gold’s 2014 performance, but the price of gold so far has rallied from $1,200 at year’s end to $1,262. Will the price continue to rise?
The precious metal’s future remains tied to Fed actions, although the next taper is likely figured into its current price. A weak dollar means strong gold prices, and buying bonds or printing money weakens the dollar. So, for the same reasons that bond prices may continue to rally, gold prices may continue to rally.
Diversify
The clear lesson from this year’s market should be that it’s important to diversify. Hedging is also an important tool, especially when uncertainty is high. Diversification combined with hedging can help you to manage risk, no matter what happens in 2014.