Stocks soar in 2013 as fear bubble pops

When Wall Street finally stopped living in fear of another bust, the opposite happened: a market boom that propelled U.S. stocks to their biggest rally in at least 16 years.

Share prices ended Tuesday with more gains, capping a stunning advance that drove the benchmark Standard & Poor’s 500 index up 29.6% for the year to all-time highs.

The narrower Dow Jones industrial average rose 26.5% in 2013, ending Tuesday up 72.37 points, or 0.4%, to a record 16,576.66.

It was extraordinarily difficult to lose money in major U.S. stocks this year as cash poured in. Within the S&P 500, 457 stocks rose for the year, or 91%, the largest number since 2003.

The gain in the S&P 500 was the biggest since 1997. The surge helped further rebuild the retirement savings accounts of millions of Americans — or at least, of those who’ve been patient enough to hang on.

The catalyst for the powerful advance was more what didn’t happen than what did: After four years of constantly looking over their shoulder for another economic and financial crash, more investors embraced the idea that the world wasn’t ending soon after all.

“We’ve been watching a bubble pop all year. The bubble was in fear,” says Eddy Elfenbein, editor of the popular Crossing Wall Street blog.

With the U.S. economy continuing to grow for a fourth straight year, though at a plodding pace, and with interest rates on savings accounts holding near zero, investors became more interested in taking risks than hiding from them.

That sentiment spread to Japan and Western Europe as well, fueling double-digit rallies in their stock markets too.

But part of what lifted U.S., Japanese and European stocks was a “wealth transfer” from other assets. Most notably, what was good for stock investors — optimism about economic growth — was bad for bond owners as long-term interest rates rose, devaluing older bonds.

And the classic haven, gold, suffered its biggest annual loss in 32 years as fear levels receded.

Here’s a look at how three key investment sectors fared:

• Stocks. The rich got much richer in 2013 as stock markets in the developed world led the way, floating on a sea of cheap central bank money. By contrast, it was a tough year for many emerging markets.

On Wall Street, the sectors often considered the riskiest performed best, as is typical in hot bull markets. Small-company stocks surged, with the Russell 2,000 index rocketing 37%, its best advance since 2003. Technology also was a standout: The tech-heavy Nasdaq composite index jumped 38.3%.

U.S. gains were dwarfed by Japan’s rally. The Nikkei-225 index soared 57% after the government and central bank vowed massive new stimulus programs to lift the economy out of its three-decade funk once and for all.

Major Western European markets mostly advanced 15% to 21% for the year, almost all in the second half, amid relative political calm and a sense that the depressed economy was finally hitting bottom.

But some of the capital that flowed into developed markets came from emerging markets, as many global investors soured on stocks in China, Brazil, Mexico, Russia and Turkey, among other countries.

Fast-growing emerging economies had been investor darlings in the early 2000s. But many now are beset with troubles: high inflation in Brazil, political upheaval in Turkey and new banking system worries in China.

“For investors in love with the emerging markets story, this was a dreadful year of love unrequited,” said Michael McNiven, a portfolio manager at Cumberland Advisors in Sarasota, Fla.

The iShares MSCI Emerging Markets exchange-traded fund lost 5.7% for the year, not including dividends.

Emerging-market fans say the losses make those markets more attractive, especially compared with roaring U.S. shares. But after scoring hefty gains on Wall Street in 2013, the question is whether U.S. investors will find it easier to stay home than look abroad in 2014.

• Bonds. A jump in longer-term market interest rates in summer drove down the value of most existing bonds, as investors began to factor in the likelihood that the Federal Reserve would begin cutting back on its unprecedented stimulus for the economy.

It turned out the market was right: At its mid-December meeting, the Fed announced that it would pare its monthly purchases of Treasury and mortgage bonds by $10 billion to a total of $75 billion.

The decision put more upward pressure on longer-term bond yields: The 10-year Treasury note yield, a benchmark for mortgage rates and other lending rates, ended Tuesday at 3.03% — up from 1.76% a year earlier and the highest since July 2011.

That meant losses, at least on paper, for many investors who have been seeking refuge in bonds since the financial-system meltdown of 2008.

Shares of the popular Pimco Total Return bond fund, for example, fell about 5% for the year. But that was mostly offset by the fund’s interest earnings. The result was a “total return” — principal change plus interest — of negative 1.9%.

Still, it was the fund’s first annual loss since 1999.

Not all bonds lost ground. The average “junk” bond mutual fund was up about 7% for the year as interest earnings more than offset principal losses.

But widespread red ink in bonds raises a crucial question for 2014: Do more investors who have been hiding in bonds since 2008 begin to rush out — and if so, do they shift into stocks on the bet that the economic expansion finally picks up steam?

As usual, many Wall Street analysts are starting the new year with optimistic economic forecasts.

“Positive trends in consumption, construction and investment — all key drivers of growth — point to a new phase in the business cycle,” said Joseph Carson, economist at money manager AllianceBernstein in New York. He thinks the U.S. economy could grow at a real annual rate of 3% to 4% for the next two to three years, which would be the fastest pace since the mid-2000s.

If longer-term rates continue to rise in the face of economic strength, bonds will lose ground automatically. The issue then becomes whether optimism in the stock market about higher corporate earnings will more than offset fears of higher rates.

• Commodities. Many investors bought into the commodity boom in the last decade. They may now be wishing they hadn’t: Unlike stocks, commodities overall have remained depressed after crashing in 2008.

Adding insult to injury, the favorite investment of hard-asset fans — gold — crumbled in 2013 as ebbing economic fears sapped demand for a hiding place.

Gold futures prices slumped to end the year at $1,202 an ounce, down 28% from a year earlier. It was the steepest decline since 1981 and ended a 12-year bull market.

A broader measure of commodities markets, the BlackRock Commodity Strategies Fund, fell 7% for the year after losing 1% in 2012.

In part, commodity prices have been held down by weak global economic growth since 2009. But another factor is that supplies of some key commodities continue to rise worldwide — most notably, output of crude oil, thanks to booming U.S. production from new fields.

For investors, depressed prices are a drag. But they’re a boon for consumers, and by keeping inflation low they may also be a check on interest rates as well.

business@latimes.com