Market Analysis

Three Down. Nine to Go.

What does a flattish first quarter mean for the rest of the year?

Does a ho-hum Q1 mean 2014 will be a bust? Many are asking after the MSCI World managed a mere +1.3%i gain over three back-and-forth months. Some fear meager stock returns signal a weak economy ahead—bad for stocks, they presume. Others want more data before making a final call. Underneath it all lies a big fallacy: the notion past performance predicts the future. As ever, stocks look forward—and we think they still have a lot to look forward to.

Just like the January Indicator gets press for being a harbinger of stock performance for the year, some view Q1 performance as a tone setter as well—and for them, a bumpy Q1 likely means a bumpy 2014. But past performance doesn’t drive future returns, and markets don’t move in straight lines. Even 2013, which many in hindsight see as a straight shot up, had its share of dips and dives.

Returns often come in bunches. 2006, for example, was flat through mid-June, but ended the second half strong—the MSCI World was up a little over 20%ii for the year. In 2010, the MSCI rose +3.2% in Q1, fell -12.7% in Q2, but rallied hard to finish the year up 11.8%.iii Nothing about Q1 and Q2’s final performance suggested big up moves were coming. Stocks don’t follow predetermined paths, and how they ended one quarter doesn’t dictate where they go next.

Nor do one quarter’s wobbles predict future gyrations. Some say January’s quick pullback indicates investors are “shifting within the market,” suggesting this means stocks bounce around the rest of the year. However, that misperceives how volatility works. Volatility is just normal. Markets can pull back for any (or even no apparent) reason. Sometimes a quick drop is tied to a big, seemingly negative story that spooks investors. That’s what happened in January’s dip. Global markets fell -5.5%iv from January 22 through February 4, due largely to jitters over currency slides in Turkey and Argentina, which many feared would trigger a broader Emerging Markets currency crisis. In reality, Turkey’s and Argentina’s troubles stemmed from localized political issues, but many believed the reduction in quantitative easing (QE) bond buying was the trigger. Headlines said the Fed was causing mass capital flight, which would leave the developing world in shambles. But two weeks after the low, markets were above breakeven. Even though Turkey and Argentina were still in a pickle and headlines were still warning of Emerging Markets’ vulnerability to the Fed’s dreaded taper. The alleged risks didn’t evaporate. Markets just got over it.

Looking ahead, it’s anyone’s guess how markets will react to the next scary story that comes—we may even see a full correction (a quick drop of -10% or greater). But maybe not! You can’t predict it. Nor do long-term investors need to try, as riding short-term volatility doesn’t prevent strong gains overall.

And strong gains are what we still expect this year. Some might suggest this forecast is premature until we know how strong the economy rebounds from some weather-related softness in Q1. But markets are forward looking. By the time a spring thaw shows up in economic data, stocks will likely already have discounted it. Markets pretty efficiently discount all widely known information—cold winter weather included. If further indicators are chilled by the frigid winter in the short term, it likely won’t shock stocks—they know extreme winter weather pulls some demand forward and pushes other activity back. They’re already looking ahead.

And in our view, they’re likely looking at the many factors that point to a good year. Many Leading Economic Indexes globally are high and rising, suggesting the world should keep growing—even as many fear it’s teetering. US firms are plowing money into R&D, equipment, software and the like—not what they do if they expect growth to slow. High and rising profits let them invest while keeping balance sheets healthy and flush with cash—a factor few appreciate. Gridlock persists in competitive developed economies like the US, UK and Germany, lowering the likelihood of radical legislation. And with sentiment only just turning optimistic, investors’ expectations still seem broadly too low—there is still plenty of room for folks to bid stocks up as sentiment improves.

i Source: FactSet, as of 4/2/2014.

ii Source: FactSet, as of 1/6/2014.

iii Ibid.

iv FactSet, as of 4/2/2014.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.