Was 2013 The Best Year Ever For Stocks?

Includes: DIA, IWM, QQQ, SPY
by: Eric Parnell, CFA

The stock market posted a remarkable performance in 2013. And given both the magnitude and consistency of the gains throughout the year amid what was otherwise a generally lackluster economy, it raises some questions for the ages. Where does 2013 rank among historical calendar year stock market performances? Is it possible that 2013 was the best year ever for stocks? And what do these strong 2013 returns mean, if anything, for the 2014 outlook?

So let's get right down into the numbers. The stock market in 2013 as measured by the S&P 500 Index (NYSEARCA:SPY) gained +32.15%. This puts the 2013 stock market in 11th place out of 85 calendar years dating back to 1929. What was perhaps even more amazing about stocks in 2013 was the consistency of the advance throughout the year, as the market posted gains in 58.33% of all trading days last year. This ranked the 2013 market 10th out of the last 85 calendar years. So while not necessarily at the top at first pass, last year's market is certainly among the best.

So what years ranked ahead of 2013 on the measures of performance and consistency? Most in the top 10 on both readings come from two distinct eras.

The first by far was the period from the 1950s and early 1960s during the great secular bull market following World War II. This period boasts three of the best years in terms of returns including 1954 and 1955, which was arguably the best two-year stretch in stock market history. Perhaps more notably, the period from the 1950s and early 1960s also contains nine of the thirteen best years in terms of market consistency including five of the six years where the stock market posted gains in more than 60% of all trading days in their respective calendar year. Of course, such extraordinarily strong and consistent stock market performance during this stretch should not come as a surprise, as the U.S. was regularly posting high single digit Real GDP growth as the lone major global market economy with the competitive advantage of not needing to completely rebuild their domestic infrastructure following World War II, a Federal Reserve that was engaged in a near decade long Operation Twist stimulus program from 1953 to 1961 and a stock market that had spent the previous two decades undergoing a massive cleansing process during the 1930s and 1940s. In short, this was an extraordinarily favorable time for stock investing, and the performance during this era fully reflects this fact.

The second era that also makes a showing on the top of the performance tables came during the heart of the Great Depression. Three of the top ten years in terms of returns including two of the top three took place in the mid 1930s in 1933, 1935 and 1936. The 1935 stock market in particular also ranked in the top ten in terms of performance consistency. It is worth noting that this period of strong performance took place after the stock market had just finished losing 89% of its value from September 1929 to July 1932, so this strong bounce back came from extremely depressed levels. Perhaps more importantly, these gains proved fleeting in the end, as the stock market made another run at its 1932 lows roughly a decade later in 1942. Regardless, this period in the mid 1930s during the depths of the Great Depression also ranks among the best of all-time on these measures.

So what about more recent history? After all, most investors today were either not alive or in their fledgling years of stock market investing at most when these two past eras took place. When focusing on the U.S. stock market since 1970, we quickly see that 2013 returns appear far more remarkable. Returns last year ranked 4th out of the 44 calendar years over this time period with only the markets of 1975 that came in the wake of the sharp 1973-74 bear market as well as both 1995 and 1997 during the inflation of the tech bubble posting better results by a few percentage points. Moreover, the 2013 stock market ranked 3rd out of 44 in terms of consistency of results, with its gains in 58.33% of all trading days bested only by the slightly higher readings in 1995 and 1989 that came in the heart of the great secular bull market from 1982 to 2000. So when viewed in the context of the modern area, the 2013 stock market ranks very near the top of the charts.

What else sets the 2013 stock market apart?

Stocks in 2013 posted by far the largest return spread over Treasuries in the modern era with a calendar year return that was +41.25% higher than the -9.10% return on Treasury bonds. It not surprisingly also posted the highest return spread over T-Bills since 1970 at +32.08%. These results were impressive even in a long-term historical context, ranking 2013 5th and 6th, respectively since 1929. The spread of stock performance over many other major asset classes was just as notable.

Stocks in 2013 also posted by far the best returns of a market that was in the fifth year or greater of an uninterrupted cyclical bull market. Like many recent baseball stars in the steroid enhanced modern era, the stock market is posting some of its best numbers late in its cyclical bull market career. Even the euphoric tech bubble year of 1999 only generated a calendar year return of +20.89% in the fifth year of the late 1990s bull market cycle, and it was notable to remember how that episode ended.

In addition, the stock market generated its heady returns last year in what has been a market environment over the last five years supported by nominal GDP growth that has ranked consistently in the bottom quartile if not bottom decile across calendar years both since 1970 and 1929. This includes four of the eight calendar years with the slowest economic growth since 1970.

Finally, the stock market in 2013 had something that no other stock market in history has enjoyed to nearly the same extent that was experienced last year. The U.S. Federal Reserve injected $1.125 trillion of liquidity into the financial system last year through its QE3 monetary stimulus program. This represented an astonishing 39% increase in the total assets on the Fed's balance sheet. Putting this in a different perspective, the Fed injected enough liquidity in the financial system to purchase the total increase in nominal U.S. gross domestic product two times over last year and would still have an extra $10 billion in cash on hand. Put differently again, it took $2.66 billion in newly printed money from the Fed for each 1 point increase in the S&P 500 Index in 2013. In short, this was a lot of money injected into the U.S. financial system at a whopping 7% of U.S. GDP.

So while 2013 may not have been the best year ever for stocks, it is at least in the discussion, particularly in the modern era since 1970s.

So in what way does any of this matter for the stock outlook in 2014? It matters a great deal for several reasons.

First, extraordinary years such as 2013 are difficult to repeat. And they are particularly challenging to replicate when coming so late in a cyclical bull market cycle. Given that stocks are now trading at nearly 20x trailing 12-month as reported earnings, it stands to question how much in the way of potential future returns was pulled forward into 2013 given the remarkable +20% multiple expansion in valuations.

Second, the impressive consistency of returns may also be difficult to repeat. Stock investors were virtually comatose to risk last year. Not only did the VIX spend most of the year at long-term lows, but the S&P 500 also remained comfortably above its 200-day moving average for the entire year. In fact, it only corrected into its 100-day moving average a mere three times, finding support in each instance. This remarkably consistent performance and gains in 58.33% of trading days was an exceptional occurrence that is rare in any market environment, much less the post crisis climate we are operating in today. In other words, the market is overdue for at least some sort of sustained correction.

Lastly, the primary driver of the rising stock market is now going away. The stock market last year that was operating in a setting of an otherwise sluggish economy with little in the way of revenue and earnings growth over the past two years was no doubt aided a great deal by the Fed's massive liquidity injections that flowed freely throughout the year. But this program is now in the process of being wound down by the Fed. So while markets will continue to receive a generous helping of stimulus as we start the year, it will become increasingly rationed as 2014 progresses. As a result, the economy and earnings will need pick up pace fairly dramatically to help fill the liquidity induced air pocket that has inflated under the stock market over the last several years. If not, we may eventually find ourselves in the converse environment where good news is bad news and bad news is bad news.

So while investors continue to celebrate the phenomenal year that was 2013, it is important to maintain at minimum a degree of caution as the New Year progresses. For just like the aging baseball stars that once basked in the glory of cheering fans as they chased the record books but are now looked upon with scorn and shame, so to may we eventually be looking at a once celebrated stock market that has succumbed to the reality that much of the tremendous performance in 2013 turned out to be falsely enhanced in the end. Only time will tell.

Disclosure: This article is for information purposes only. There are risks involved with investing including loss of principal. Gerring Capital Partners makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made. There is no guarantee that the goals of the strategies discussed by Gerring Capital Partners will be met.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long SPLV, XLU and selected individual stocks.