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May 2013

Annual stock market returns are very much like sprinters in a race—getting off to a good start means everything, and oftentimes it portends good things to come. The stock markets jumped out of the gates in 2013 posting solid returns for January. They carried that momentum into February and closed out the quarter with double digit returns in most major domestic indexes. In this issue of Market View we will take a look at first quarter performances, analyze what the fast start could mean for the markets, and also discuss why REDW Stanley still believes in diversification. In the first quarter issue of 2012’s Market View, titled, “Climbing a Wall of Worry?” some of you might remember that we were optimistic about the year ahead and referenced research to support our position. The following is an excerpt from that issue:


According to Yardeni Research there were 17 times in the last 66 years that each of the first three months of the year have posted positive S&P 500 returns like we have this year. The average total yearly return for those 17 years was 20.2 percent, with NONE of those years posting a negative return.

include dividends, was 10.03 percent for the first quarter of 2013. Although the 16 percent return of last year effectively dragged the average return down (for the 18 times that the S&P 500 index posted positive returns for the first three months of the year) to a paltry 19.97 percent average return, the record of never posting a negative return in those years remains intact. And of course we are joking about being disappointed with a 16 percent return and 19.97 percent average. We also want to remind you that past performance is no guarantee of future performance, but it always feels better when we feel the odds are with us.

While it turned out to be a relatively good year with a 16 percent return on the S&P 500, we were very disappointed that we didn’t reach the average of 20.2 percent. The good news is, it appears that we will have another chance this year to surpass that 20.2 percent average return. That’s right, the S&P 500 percentage change, which doesn’t

The fast start this year is actually being fueled by small cap stocks with the Russell 2000 posting a 12.03 percent increase, followed by the Dow Jones with an 11.25 percent increase, and then the NASDAQ with an 8.21 percent increase for the quarter. Not surprisingly, with Europe still struggling and emerging markets floundering a bit, the U.S. markets outperformed

the world markets with the MSCI World ex USA index increasing 4.70 percent for the quarter. The world has certainly become a frightening place, and as investors scour the globe for investment opportunities, the U.S. seems to be the country of choice, so our markets continue to lead the way. When will that change? That is the million dollar question and one that we do not even pretend to know the answer to. Different sectors and asset classes move at different times and some move in opposite directions of each other. Having a diversified portfolio reduces risk and assures participation in an advancing market. We rely on empirical data that indicates the stock market goes up more than 70 percent of the time, so it advances at more than a two-to-one rate of when it declines. We all have friends who insist on buying individual stocks and having a concentrated portfolio, but that is a difficult and risky way to build wealth. Let us take you back to the beginning of 2012 to plead our case for diversification.

It’s New Year’s Day 2012. In addition to overdosing on televised college football, you’re spending part of the holiday working on the family finances. Armed with a laptop and various online financial tools, you’re on the hunt for appealing stock market opportunities. To prune the list of candidates to a manageable size, you decide to focus on firms that are leaders in their respective industries and exhibit above-average scores on various measures of financial strength. As you work your way through the alphabet, you come to the “P” stocks, and another candidate appears. It’s a prominent player in a major industry (good), but operates in a notoriously cyclical industry (not so good), is currently losing money (definitely not good), pays no dividend, and has a junk-bond credit rating of BB-minus. Next! You push the “delete” key and move on. Congratulations. You just passed up the best-performing stock in the entire S&P 500 Index for 2012. Shares of PulteGroup, a Michigan-based homebuilder with a 60-year history, jumped 187.8 percent last year amid strong performance for the entire industry. For the year ending December 31, 2012, all 13 homebuilding firms listed on the New York Stock Exchange outperformed the S&P 500 Index by a wide margin, with total returns ranging from 34.1 percent for NVR to 382.8 percent for Hovnanian Enterprises. The Standard & Poor’s SuperComposite Homebuilding Sub-Index rose 84.1 percent in 2012 compared to 13.4 percent for the S&P 500 Index (the return was 16 percent with dividends included). The point? For those seeking to outperform the market through stock selection, underweighting the market’s biggest winners can be just as painful as overweighting the biggest losers. Investors are often caught flatfooted by stocks that do much better or much worse than the broad market,

and the problem is not limited to individuals. Not one of the 10 seasoned professionals participating in Barron’s annual Roundtable stock-picking panel in early January 2012 mentioned homebuilding stocks or any housingrelated firms.

readers that, when in doubt, fall back on the fundamentals; and while we did not look at specific fundamentals in this issue of Market View, most indicators are still slightly undervalued or fairly valued. This is good news because we are of the belief that when the pendulum begins to swing back toward the mean, it doesn’t stop right at the mean but continues well past it. Translation: even if we are at fair value, we believe there is still plenty of room for the market to increase.

The recent surge in housing shares also serves as a reminder that stock prices are forward-looking and tend to rise or fall well in advance of clear changes in company fundamentals. Investors who insist on waiting for evidence of healthy profits before investing are often frustrated to find that a firm’s stock price By Jude V. Gleason, CFP®, AIF®, MBA has appreciated dramatically by the Chief Investment Officer time the firm begins to report cheery financial results. Shares of Hovnanian Enterprises, for example, rose 580 percent between October 7, 2011, and December 31, 2012, even though the firm continued to report losses. Similarly, it is not unusual for a firm’s stock price to decline long before signs of trouble become obvious. Many observers in recent years predicted that a recovery in the housing industry would be agonizingly slow, and they were right. Many investors in recent years have avoided housing stocks as a consequence, and they’ve been wrong; housing stocks have outperformed the broad U.S. stock market by a healthy margin from the market low in March 2009 to the present day. BOTTOM LINE: Markets have 101 ways to remind us of Nobel laureate Merton Miller’s observation— diversification is the investor’s best friend. In closing, we would like to say that there is nothing wrong with investing in individual stocks as long as it is still done in the context of a well-diversified portfolio, but oftentimes that is not the case. We would also like to remind our

2 Copyright 2012 REDW Stanley Financial Advisors, LLC. All Rights Reserved. This publication is intended for general informational purposes only. The information contained does not constitute legal financial, accounting, or other professional advice.

Diversification and the Average Investor Maximizing the Power of Diversification (1994 – 2012) Traditional Portfolio

More Diversified Portfolio Equity Mkt. Neutral Commodities 8%




S&P 500




Barclays y Agg. gg


S&P 500 Russell 2000

4% 22%




MSCI EM Barclays Agg.

Return: 7.43% Standard Deviation: 10.80%

Return: 7.72% Standard Deviation: 9.87%

20-year Annualized Returns by Asset Class (1993 – 2012) 12%


10% 8.4%



Asset Class

8% 6.5%


6% 4% 2.7%





Average Investor


(Top) Indexes and weights of the traditional portfolio are as follows: U.S. Stocks: 55% S&P 500; U.S. Bonds: 30% Barclays Capital Aggregate; International Stocks: 15% MSCI EAFE. Portfolio with 25% in alternatives is as follows: U.S. Stocks: 22.2% S&P 500, 8.8% Russell 2000; International Stocks: 4.4% MSCI EM, 13.2% MSCI EAFE; U.S. Bonds: 26.5% Barclays Capital Aggregate; Alternatives: 8.3% CS/Tremont Equity Market Neutral: 8.3%, DJ/UBS Commodities: 8.3% NAREIT Equity REIT Index Index. Return and standard deviation calculated using Morningstar Direct. Charts are shown for illustrative purposes only. Past performance is not indicative of future returns. Diversification does not guarantee investment returns and does not eliminate risk of loss. Data are as of 3/31/13 3/31/13. (Bottom) Indexes used are as follows: REITS: NAREIT Equity REIT Index, EAFE: MSCI EAFE, Oil: WTI Index, Bonds: Barclays Capital U.S. Aggregate Index, Homes: median sale price of existing single-family homes, Gold: USD/troy oz, Inflation: CPI Average asset allocation CPI. investor return is based on an analysis by Dalbar Inc., which utilizes the net of aggregate mutual fund sales, redemptions and exchanges each month as a measure of investor behavior. Returns are annualized (and total return where applicable) and represent the 20-year period ending 12/31/12 to match Dalbar’s most recent analysis.

0% REITs


S&P 500





Asset Class Returns 2003 MS CI EME 56.3% Russe ll 2000 47.3% MS CI EAFE 39.2%

Asset Class






Ba rc la ys Agg 5.2%

MS CI EME 79.0%

1. 8 %

MS CI EAFE 32.5%









Russe ll 2000 26.9%

Ba rc la ys Agg 7.8%

3 1. 6 %

MS CI EME 34.5%

3 5 . 1%

MS CI EME 39.8%

MS CI EME 26.0%

DJ UBS Cmdty 2 1. 4 %

MS CI EME 32.6%

DJ UBS Cmdty 16 . 2 %

MS CI EAFE 20.7%

MS CI EAFE 14 . 0 %

MS CI EAFE 26.9%

MS CI EAFE 11. 6 %

Ma rke t Ne utra l 1. 1%


MS CI EME 19 . 2 %

Ma rke t Ne utra l 4.5%

MS CI EAFE 17 . 9 %

Ma rke t Ne utra l 9.3%

Asse t Alloc . - 24.0%

Russe ll 2000 27.2%

DJ UBS Cmdty 16 . 8 %

S &P 500 2 . 1%



Ca sh



10-yrs '03 - '12 Cum. Ann.

19 . 7 %

Russe ll 2000 12 . 4 %

MS CI EME 376.0%

MS CI EME 18 . 6 %

S &P 500 10 . 6 %




11. 8 %

8 . 1%

Russe ll 2000 15 2 . 8 %

Russe ll 2000 9.7%

Russe ll 2000 16 . 3 %


MS CI EAFE 13 0 . 3 %


0 . 1%

S &P 500 16 . 0 %

Asse t Alloc . 5.0%

Asse t Alloc . 117 . 7 %

Asse t Alloc . 8 . 1%

Ma rke t Ne utra l 0.7%

S &P 500 98.6%

S &P 500 7 . 1% Ba rc la ys Agg 5.2%


MS CI EME 16 . 9 %

3 7 . 1%

Russe ll 2000 18 . 3 %

12 . 2 %

Russe ll 2000 18 . 4 %

S &P 500 28.7%

Asse t Alloc . 12 . 5 %

Asse t Alloc . 8.3%

S &P 500 15 . 8 %

Asse t Alloc . 7.4%

Russe ll 2000 - 33.8%

S &P 500 26.5%

S &P 500 15 . 1%

Asse t Alloc . 2 5 . 1%

S &P 500 10 . 9 %

Ma rke t Ne utra l 6 . 1%

Asse t Alloc . 15 . 2 %

Ba rc la ys Agg 7.0%

DJ UBS Cmdty - 35.6%

Asse t Alloc . 22.2%

Asse t Alloc . 12 . 5 %

Asse t Alloc . - 0.6%

Asse t Alloc . 11. 3 %

DJ UBS Cmdty 23.9%

DJ UBS Cmdty 9 . 1%

S &P 500 4.9%

Ma rke t Ne utra l 11. 2 %

S &P 500 5.5%

S &P 500 - 37.0%

DJ UBS Cmdty 18 . 9 %


Russe ll 2000 - 4.2%

Ba rc la ys Agg 4.2%


Ba rc la ys Agg 65.7%

Ma rke t Ne utra l 7 . 1%

Ma rke t Ne utra l 6.5%

Russe ll 2000 4.6%

Ca sh

Ca sh


MS CI EAFE - 11. 7 %

Ma rke t Ne utra l 0.9%

Ba rc la ys Agg - 0 . 1%

Ma rke t Ne utra l 6 1. 5 %

Ma rke t Ne utra l 4.9%

0 . 1%

DJ UBS Cmdty - 1. 1%

DJ UBS Cmdty 49.3%

DJ UBS Cmdty 4 . 1%




Ba rc la ys Ba rc la ys Agg Agg 4 . 1% 4.3%


Ba rc la ys Ba rc la ys Agg Agg 5.9% 6.5%



- 37.7%


Ba rc la ys Agg 4.3%

Russe ll 2000 - 1. 6 %

MS CI EAFE - 4 3 . 1%

Ma rke t Ne utra l 4 . 1%

Ca sh

Ca sh

0 . 1%

DJ UBS Cmdty - 13 . 3 %

Ca sh

Ca sh

Ca sh

Ca sh

Ca sh

Ba rc la ys Agg

DJ UBS Cmdty



Ca sh

Ma rke t Ne utra l


DJ UBS Cmdty


Ca sh

Ca sh

1. 0 %

1. 2 %


2 . 1%

- 15 . 7 %

- 53.2%

0 . 1%

- 0.8%

- 18 . 2 %

- 1. 1%

- 1. 6 %

18 . 2 %

1. 7 %

Source: Russell Russell, MSCI, MSCI Dow Jones Jones, Standard & Poor Poor’s s, Credit Suisse Suisse, Barclays Capital, Capital NAREIT NAREIT, FactSet, FactSet J.P. J P Morgan Asset Management Management. The “Asset Allocation” portfolio assumes the following weights: 25% in the S&P 500, 10% in the Russell 2000, 15% in the MSCI EAFE, 5% in the MSCI EMI, 25% in the Barclays Capital Aggregate, 5% in the Barclays 1-3m Treasury, 5% in the CS/Tremont Equity Market Neutral Index, 5% in the DJ UBS Commodity Index and 5% in the NAREIT Equity REIT Index. Balanced portfolio assumes annual rebalancing. All data represents total return for stated period. Past performance is not indicative of future returns. Data are as of 3/31/13, except for the CS/Tremont Equity Market Neutral Index, which reflects data through 2/28/13. “10-yrs” returns represent period of 1/1/03 – 12/31/12 showing both cumulative (Cum.) and annualized (Ann.) over the period. Please see disclosure page at end for index definitions. *Market Neutral returns include estimates found in disclosures. Data are as of 3/31/13.

3 Copyright 2012 REDW Stanley Financial Advisors, LLC. All Rights Reserved. This publication is intended for general informational purposes only. The information contained does not constitute legal financial, accounting, or other professional advice.

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Market View (May 2013)