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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next72 hours. (More...)

What a Difference a Year Makes

After feasting on the U.S. stock market's 54% run-up from 2009 to 2010, we starved for performance in 2011,

suffering a 1% loss. Some said the markets were due for a respite, so this lull was healthy, and they were right.Stock markets both here and abroad subsequently had a good year in 2012 followed by a spectacular 2013,

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2013 Was A Very Good Year, But Some Market

Segments Have Flourished More Than Others

Jan. 14, 2014 9:19 AM ET | by: Ronald Surz Includes: DIA, QQQ, SPY

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generating a 54% two-year U.S. market return. The 2011 loss is sandwiched between two 54% return 2-yearperiods.

(click to enlarge)

The past five years have been among the best on record, almost erasing the memory of the previous five yearsending 2012, as shown in the graph below. These past five years produced the third highest return, as shownin the following graph, albeit it follows two of the lowest performing 5-year periods.

(click to enlarge)

Source: PPCA Inc

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(click to enlarge)

The U.S. stock market has performed best, particularly in 2013, as shown in the graph above. Consequentlythere is a wide dispersion of performance among multi-asset managers, especially target date funds. Theprimary benefits of target date funds are diversification and risk control, both of which suffered on a relative

basis in 2013. As shown in the graph below, the most diversified funds underperformed their U.S.-centriccompetitors, as did funds with rigorous risk controls. This leads to the potential for error on the part of plan

sponsors, hiring and firing investment managers for the wrong reasons.

(click to enlarge)

Using the return components formula above, the U.S. stock market's 2013 return breaks down as follows:

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33% Return = 2% Dividend + (6.5% Earnings Growth compounded with 23% P/E Expansion)

As usual, some styles and sectors have thrived while others have struggled. Similarly, outside the U.S. therewas a wide range of country performance. The following section examines these results.

Winners and Losers in 2013 and the 5 Years Ending 2013

U.S. stocks

Growth stocks led the way in 2013, with small-cap growth stocks performing best, earning 44%. By contrast,

large-cap-core companies earned "only" 23%, and large-value earned only 28%. Other than these extremes,style returns clustered around 30%, a pretty good place to be. This has been one of those unusual periods

where the "stuff in the middle" (CORE) has not performed in line with the "stuff on the ends." I use SurzStyle Pure classifications throughout this commentary. It wouldn't be surprising to see core outperformvalue and growth going forward, in a regression toward the mean.

On the sector front, consumer discretionary and health care fared best, earning more than 43%. By contrast,materials eked out a measly 7% return, and telephones-&-utilities also lagged with a 16% return. It was a yearled by consumers, in contrast to previous periods that were led by infrastructure spending and the Chindiaeffect.

Looking back over the past 5 years smaller companies of all styles have led the way, as have consumer-oriented stocks. The big change in 2013 was in the leadership of technology stocks, which had performedrelatively well prior to 2013. It's also interesting to note that the previous 5 years (2004-2008) were led by

value stocks in the energy and materials sectors. The leadership of the U.S stock market has shifteddramatically.

But the interesting details lie in the cross-sections of styles with sectors, especially if we are interested inexploiting momentum effects, as discussed in the complete commentary (see endnote).

Foreign stocks

Looking outside the U.S., foreign markets earned 16.5%, lagging the U.S. stock market's 33% return and

EAFE's 23% return. Japan and Europe are the big story, earning 30% on a dollar basis. The Japan return inJapanese yen was an even more impressive 44%. The Japanese stock market has soared this year as the yen

was purposely weakened against the dollar. By contrast, all countries outside Europe and Japan earned lessthan 11%, and Latin America lost 4%, all in $US.

On the style front, core surprised, as it did in the U.S., but core led rather than lagged, although not by much.

Looking back over the past 5 years leadership in 2013 shifted away from Latin America and

Australia-&-New Zealand to Japan and Europe, and style leadership shifted from value to core. EAFE and

ADRs have both underperformed the total market. This is because smaller companies have performed best,earning 20% per year while large companies have lagged with annualized returns of 16% per year.

In my 2012 Commentary, I observed that Japan had become a bargain, a deep value play, coming into 2013 --a pretty good call. As concerns about a weakening U.S. dollar have been allayed, at least for now, interest has

diminished in emerging markets, Latin America, and Australia-&-New-Zealand.

Conclusion

2013 was a very good year, leading some to predict more of the same while others are concerned that marketsmay have overshot, so we'll see a correction in 2014. Given the uncertainties that lie ahead with governmental

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dysfunction, quantitative easing, geographic unrest, etc., a cautious approach is in order.

Endnote

This article is excerpted from a longer commentary available here.

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Forecasts Of Stock Market Returns In 2014 And Beyond, Including Forecasts For Styles, Sectors And

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