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The S&P 500 has been on fire this year; in fact it has been on fire since March 2009. In the process, it has beaten every single major asset class, bonds, managed futures, hedge funds, commodities as well as other equity indices, European, Asian, Emerging Markets as well as Frontier markets.

This is a table of the cumulative monthly returns since 2009 of various asset classes as well as primary global equity market indices; SPY (SPDR S&P 500 ETF), FEZ (SPDR EURO STOXX 50 ETF), EEM (iShares MSCI Emerging Markets ETF) and NAFAX (Nile Pan Africa Mutual Fund, Class A) which is a proxy for frontier markets represent the primary global equity indices.

BONDS are the returns of the 30-year US government Treasury bond; BTOP is the Barclayhedge BTOP 50 Index (a proxy for managed futures), HFR Global Hedge Fund Index and the Equity Hedge Index as a proxy for hedge fund returns.

(click to enlarge)

Looking Forward

The past few years have been stellar for the S&P 500, but what about the future? David Tepper, the founder of Appaloosa, a very large hedge fund was on Bloomberg TV recently, saying that the party is not over and the market is not in a bubble. He presented fundamental reasons pointing to P/E multiples arguing that the market is set to go higher and the S&P 500 could be up 20% in the next 6 months.

The big risk in the markets next year is the Federal Reserve. Does the Federal Reserve taper or does it not. We do not think even it knows what to do, but we know one thing. Chances are high that Janet Yellen will be the next Fed chief and she is no hawk. In 2005 she argued against deflating the housing bubble and her track record of voting at the FOMC meetings clearly shows her dovish feathers. Therefore, while it is likely that the equity market could pull back when the Fed does taper, it will be well supported by plentiful liquidity with Yellen at the helm.

We at MA Capital, while keeping an eye on economic fundamentals, rely on a purely systematic approach to investing. Our models look at the underlying market volatility to predict bull versus bear markets. A look at our models also shows no immediate threat of volatility in the markets.

In the chart below, we show the SPY index (green), the index daily returns (BLUE) and our proprietary risk indicator (red). As it is shown below, the indicator starts to fall before we enter periods of high volatility. High volatility periods are usually precursors to a fall in the underlying market as can be seen in the fall of the SPY index.

Chart of Daily Returns Versus our Proprietary Risk Indicator (1/2006-11/2013)

(click to enlarge)

A combination of monetary policy outlook, large investor sentiment and our own technical factors point to a favorable risk outlook for equities as we go into 2014. But the question becomes: is the S&P 500 the best asset to hold in your portfolio for 2014?

Global Equity Indices

As we showed in the table above, global equity indices have lagged the S&P 500 due to a myriad of issues. Europe has been mired in recession and has been on an austerity path, unlike our easy monetary policy of QE that has been feeding the S&P 500. S&P recently downgraded Netherland's AAA rating and thinks that it will take until 2017 before Europe's growth starts to reach 2008 levels. While not falling off a cliff, European growth is slow and hampered by austerity, which means that European stock indices will most likely continue to lag the US.

We are relatively very bullish on Asian markets and the frontier markets of Africa. China recently announced an end to the one child policy, which should see a pickup in demand from expanding families. Stabilizing global economies also bodes well for its export sector as can be seen in a pickup of its export numbers in October.

India will go through major elections in 2014, with a strong possibility that a pro-growth and capitalist minded BJP government led by Narendra Modi will win the elections. The Reserve Bank of India has a new chief, who has already embarked on big changes to stabilize the currency and improve growth.

The frontier markets of Africa have twin drivers; domestic consumption and exports to China and Europe. Despite weak demand for the past few years from both Europe and China, NAFAX (Nile Pan Africa Mutual Fund) has been up more than the S&P over the last 2 years. A stabilizing Europe and increased demand from China should see the frontier markets of Africa out-perform the S&P 500 next year.

Bonds

Simply put, we are not bullish bonds. So far in 2013, there have been inflows of almost $280 billion into equity mutual funds and exchange traded funds. This puts October as the fifth largest inflow month in the history, but most of this money has come into stock funds and the expense of bond funds.

A tapering of the QE will be the hardest felt by bonds and with equity markets rising 15% to 20%, why would anybody want to be in bonds earning 3%?

Hedge Funds

In a recent article, titled Constructing a Robust Absolute Return portfolio, we showed that while hedge funds do not fall as much as stock markets do in a high volatility risk-off environment, they lag the S&P 500 when we are in a low volatility, risk-on environment. Therefore, if our analysis is correct and we are in a low risk environment through at-least 2014, it is probably wiser to have a direct exposure to the stock indices than hedge funds.

Managed Futures Mutual Funds

There are a lot of benefits to holding an uncorrelated asset class like managed futures in your portfolio, especially if we enter a high volatility period. But, alternative asset classes are best sourced through a hedge fund and not a mutual fund. There are several structural drawbacks to accessing alternatives like managed futures through mutual funds, which we pointed out in a recent blog post as well. So, we would stay away from any mutual funds offering managed futures and look for hedge funds in this space.

The risk environment currently looks benign, as we showed in the chart above with our risk indicator, which means that an exposure to stock indices is the best way to go for 2014. While we like the S&P 500, we believe that the Asian and African markets will perform the best in 2014.

Source: Best Assets For Your 2014 Portfolio

Additional disclosure: Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by MA Capital Management, LLC unless a client service agreement is in place. Nothing in this article should be construed as a solicitation or offer, or recommendation, to buy or sell any security, or as an offer by MA Capital Management, LLC to provide advisory services. Investment management services are offered only pursuant to a written Customer Agreement, which investors are urged to read and carefully consider in determining whether such agreement is suitable for their individual facts and circumstances.