Early 2010 was marked by continued uncertainty in the wake of the Great Recession and the “Flash Crash” that spooked the markets. But in August, QE2 sparked a risk-on rally that lifted the S&P 500 from about 1,000 to more than 1,250 by year-end.
Amid a U.S. credit downgrade, the European debt crisis and a China slowdown in 2011, defensive dividend stocks had their moment. Though the broader S&P index was flat on the year, the Utilities SPDR ETF (XLU) put up 14% returns in calendar 2011 and the Consumer Staples SPDR ETF (XLP) gained almost 9% in 2011.
Then the money moved to so-called “frontier markets” in 2012. Thailand, Egypt, Turkey and the Philippines all tacked on gains of 35% or more on the year — about triple the S&P 500.
In 2013, the story returned to domestic equities — particularly the tech sector. While the markets are up strongly across the board with about 20% gains, momentum darlings like Netflix (NFLX) and LinkedIn (LNKD) have tacked on much more than that.
So what will be hot in 2014?
Well, it’s difficult to say. The U.S. economy and the stock market in general continues to muddle through the overhang of the Great Recession. The environment remains challenging for many companies, and valuations aren’t as attractive as they once were.
But while picking winners is no easy task, it’s not that difficult to see what will be ice cold in 2014. Macro trends and market pressures are already emerging that indicate these three investments are doomed in the next year.
But they should also cash out ASAP, because that kind of momentum cannot last.
Those who have been around since before the dot-com crash should see the writing on the wall right now in regards to tech stocks — the narratives are eerily similar.
Internet companies without meaningful revenue — like Pinterest — are touted as tremendous opportunities and valued as multi-billion-dollar companies. Dealmaking is also red hot right now. Whether it’s cash-rich companies like Yahoo (YHOO) chasing social media and mobile acquisitions left and right, or a number of tech IPOs exploding out of the gate lately there is a race to be “in on the ground floor.”
Obvious barriers to success are simply overlooked. In the case of Netflix, nobody cares about the continuous cash bleed overseas or the threat of competition and bandwidth issues for high-speed internet at home. In the case of Tesla (TSLA), the value implies that the stock will flawlessly execute its strategy and that the market will fully embrace it for years to come.
This is not to say that some tech stocks are not fairly valued, or that some companies don’t have a very real path for success in 2014. But be very careful painting the tech sector with a wide brush — particularly stocks with nosebleed P/Es that have already doubled or tripled in the last 12 months.
Sure, interest rates remain low as the Fed keeps its easy money policies in force.
However, the increased talk of “tapering” should alert investors to the fact that central bank policies can’t stay loose forever — and if interest rates rise either because of a hard increase to the Fed funds rate or simply because that’s what market sentiment dictates, it can take a bite out of your long-term bond investments over the next year.
Thanks to the inverse relationship between price and yield, increasing interest rates will mean you lose value in bond funds. Consider that from May to early July, when rates on the 10-year T-Note rose about 1%, the iShares 20+ Year Treasury Bond ETF (TLT) lost about 15%. That’s because 95% of the holdings are more than 25 years in duration, and the longer the duration, the more susceptible bonds are to interest rate increases.
If you own actual bonds and hold to maturity you don’t need to worry about this; instead of rolling your money over into new long-term bonds, you’re simply holding your investment and collecting the income.
However, many investors prefer to invest in bond funds for the diversification and ease of trading — and the fact that your manager will be buying new long-term bonds in 2014 right before interest rates rise will mean you could take a significant haircut on the total value of your investment.
Dividend stocks are a powerful investment for the long-term, and most investors looking for income have few options right now in a low interest rate environment.
However, these facts don’t mean that dividend stocks are always the best investment — especially if you are hoping for capital gains in addition to the dividend potential.
Mebane Faber of Cambria Investment Management recently pointed out that dividend stocks normally trade at a deep discount to the broader market, including a period in 1997 when the P/E of defensive sectors was sometimes as much as 40% below the relative P/E of the broader market.
But right now, defensive dividend stocks are actually trading at a premium of 20% … which could mean underperformance and deep declines if that ratio corrects.
Consider that dividend stalwarts like Coca-Cola (KO), which is up just 9% vs. a 24% run for the market in 2013, have grossly underperformed year-to-date. And more recently, the drop-off in defensive dividend players has been accelerating. While the S&P 500 is up 8% since September 1, some defensive plays like Merck (MRK) are in the red and others including Walmart (WMT) and Caterpillar (CAT) are barely hanging on to 1% gains.
Sure, long-term and income investors should consider dividend stocks a powerful part of their portfolio. But don’t be fooled into thinking that these defensive stocks are your best bet just because they boast big brands and offer decent yield.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. As of this writing, he did not hold a position in any of the aforementioned securities. Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP.