After a year like 2013, I can fully understand why many investors are unlikely to have risk on their minds. The one pullback we saw last year, a -7.5% decline in May-June, was quickly reversed with the S&P 500 (SPY) at new highs within a few weeks of the low (see chart below). The “Buy the Dip” mantra has become engrained in the minds of investors as corrections have become a “thing of the past.”
Unfortunately for investors, 2013 was the exception, not the rule. Since 1928, the S&P 500 has had an average of 3.5 corrections per year of greater than 5%. Last year, of course, we only saw one. Additionally, the annualized volatility in stocks last year of 11% was well below the historical average of 16.5% and was actually lower than the volatility of long-duration bonds (TLT).
Early in 2014, investors may be slowly waking up to the fact that things may be different this year, with the S&P 500 down through the first five trading days and asset classes that had performed poorly in 2013 such as Bonds (TLT) and Gold (GLD) up on the year. This is not to say that stocks cannot have a good year in 2014, just that investors should not be expecting this year to mirror 2013 in terms of low volatility and little dispersion (93% of stocks in the S&P 500 finished higher in 2013, a record high).
The key question, then, is what are the major risk factors for investors to watch out for in early 2014? While everyone will have a different answer to this question, these are the 4 risk factors and related charts that I am watching closely in the early going: