Here's one last goodbye to 2013 and a handful of warnings and predictions for the year ahead.
The chart below shows the cumulative drawdowns from annual peak equity prices by year over the history of the S&P 500.
The fond goodbye to 2013 comes after one of the quietest years on record -- a year with so little downside risk in large cap U.S. equities that it almost didn't matter what you bought.
The warning comes from the long history of market dislocations and the fact that the market's random walk should not lead us to expect another year like the last one. And the chart above is cheating, a little, since it resets drawdown values with each new year. Here is a starker picture: the 10 largest peak to trough drawdowns in S&P 500 history.
Now, stock valuations aren't all that high. And despite the special pleading of hyperinflationistas with books and gold bars to sell, the normalization of monetary policy in the U.S. is a major positive sign. The Millennials are just now getting a taste of what it's like to be of working age in an economy with a bright future, and the energy outlook that was such a concern during the last economic cycle is suddenly not so dire. In broad terms, there's no reason to pay drawdown tables any special attention.
From a tactical perspective, though, it would be foolish to lean harder on long-anything equity trades in the year ahead. Even if there are no major policy missteps or international crises to disrupt markets in 2014, we might just see a year of less upside drama: a year in which wages are allowed to play a little catch-up while equity prices mark time.
Here are some predictions.
- For options and volatility traders, the money to be made in 2014 will come not from changes in the level of implied volatility, which is already fairly low, but from the carry and rolldown in the implied volatility term structure. After a year where equity call buyers could do no wrong, it would not be surprising to see some quarters where the only winners are gamma shorts, where the straddle jockeys and condor sellers and pickers-up of steamroller-threatened nickels are rewarded for taking risks.
- The spot VIX will touch 20 at some point during the year, and people will act like it's a big deal.
- China will try to downshift their growth, but will slip up here and there and in 2015 we'll still be talking through Michael Pettis's scenarios.
- It will be worth learning more about the downstream segment of the energy industry.
- The yen trade will get less crowded in a hurry this spring.
- At least two EDHEC hedge fund style groups will outperform passive equity indexes.
- Three exchanges will list equity index volatility futures and South Korea's will attract respectable volume.
- The GOP will try some tactical fiscal subtlety and find more success than with brute force; the Warren/Clinton lines will get sharper.
- 20- and 30-somethings who were raised evangelical Protestant and then lapsed will attend mainline / liberal churches when they start having children.
- Something even less impressive than Snapchat will come along and attract an even wilder valuation. Zuckerberg will insist that FB is not just aunties at this point.