Practical analysis for investment professionals
23 December 2013

Best of 2013: Taking Stock of Equities

As 2013 comes to a close, we take a look back at, and highlight below, some of the stories that captured the attention of investors and helped set the trend for global equity markets over the past 12 months. With the notable exception of emerging markets, it was (as of this writing) a year of impressive gains for most major stock markets, particularly in light of what has been a persistently sluggish economic backdrop.

Best wishes for the New Year. We look forward to continuing the dialogue.

The Great Rotation Fallacy

A popular theme heading into 2013 was that a “great rotation” from fixed income to equities would propel stocks higher. The thinking was that bonds were “over-owned” and stocks were “under-owned” and that a reversal was in order. However, this thesis was flawed: The perceived over-investment in bonds was simply because the amount of debt outstanding relative to equity has been higher than normal, in large part due to companies taking advantage of record low interest rates.

Further, as John Hussman pointed out, “To assert that stocks can be ‘underowned’ seems to reflect either a misunderstanding of how markets work, or a desire to distribute overvalued institutional holdings onto the unwashed muppets. Likewise, the idea of a ‘rotation’ out of bonds and into stocks begs the question of who will buy the bonds and sell the stocks, as someone must be on the other side of that trade.”

Revitalized IPO Market

At the beginning of 2013, the market for new issues was struggling, prompting us to ask, “What Ails the IPO Market?” We suggested that Twitter’s (TWTR) much-anticipated public debut would bring renewed interest to IPOs, but the magnitude of the rebound surprised us. By the fourth quarter, the IPO market was on pace to have its busiest year since 2000. Despite what some investors might characterize as a building froth, when we polled readers of the CFA Institute Financial NewsBrief last month, only 28% found the upswing in IPO activity “troubling and indicative of a bubble.”

Frontier Markets Surprise

Emerging markets were laggards in 2013, earning them the well-worn sobriquet “submerging markets.” In contrast, the strong returns posted by frontier markets caught many investors off guard. Often referred to as “pre-emerging” markets, frontier market equities satisfied the appetites of investors looking for growth at a time when emerging markets, more leveraged to the global economy, felt the effects of the global economic slowdown.

Activist Investors Take Center Stage

Activist investors seemed to dominate the business headlines this year. Bill Ackman, David Einhorn, Dan Loeb, and Carl Icahn were some of the more high-profile managers who publicly pressed companies for change. Ackman’s feud with Icahn over Herbalife (HLF), and Loeb’s battle with Sony (SNE) were just some of the interesting stories involving activists in 2013. The contributions of activist investors were thoughtfully considered by my colleague Matt Orsagh, and Vanity Fair’s compilation of “Loeb’s Top 10 Most Scathing Letters” is a quick and entertaining read.

Corporate Profits Defy Gravity

A recurring theme throughout 2013 was lower earnings guidance from companies, followed by modest earnings “beats” over the first three quarters. Forgiving or forgetful, investors seemed to shrug off the lowering of the earnings bar this year. With profit margins and corporate profits as a percentage of GDP at all-time highs, the sustainability of earnings is on investors’ minds.

Two months ago we surveyed investors about the direction of profit margins and found only 38% expecting them to contract over the next year. We reminded readers that Warren Buffett once said, “You have to be wildly optimistic to believe that corporate profits as a percent of GDP can, for any sustained period, hold much above 6%” (they stand at about 11% today). And GMO’s Jeremy Grantham has called profit margins “the most mean-reverting series in finance.” On the other side of the argument is Jeremy Siegel, who thinks increasing globalization, a fast-growing (and highly profitable) technology sector and low interest rates will help keep profits high.


Tesla’s (TSLA) stock was on fire for much of the year, until stories of the car’s batteries literally catching fire caught regulators’ attention and dampened the enthusiasm of investors. Tesla’s disruptive technology and soaring stock has left many investors “Teslanaires.” The company has also attracted scrutiny from discriminating observers like valuation pro Aswath Damodaran, who has a less generous opinion of the company’s value. This short video from GreenWood Investors does a nice job summarizing why Tesla may be a bit overhyped.


The most anticipated IPO since that of Facebook (FB) — Twitter (TWTR) — went public with great fanfare in November and, as of this writing, has more than doubled in price. In time, Twitter may fundamentally alter how Wall Street research is disseminated. For now, investors would do well to examine how the company will turn its competitive advantage into profits. Already, Twitter’s accounting has been criticized, and value-oriented investors should consider the valuation being accorded its shares.

Capitulation by the Bears

Bearish sentiment, often seen as a contrary indicator of future market direction, has retreated towards record-low levels, and we have seen high-profile strategists and investors, including David Rosenberg and Hugh Hendry, change their tune and warm to stocks. Amusingly, Hendry said, “I may be providing a public utility here, as the last bear to capitulate. You are well within your rights to say ‘sell.’”

Wall Street in Focus

Wall Street’s ongoing effort to repair its reputation was often overshadowed by headlines of government investigations. SAC Capital and JP Morgan were in the crosshairs of the US government throughout the year. Regrettably, one blueprint for success in finance — recklessness — still holds, and it is the industry’s job to address the incentives that lead to bad behavior. A recent study designed to decipher the “black box” of sell-side analyst decision making found that nearly a quarter of the analysts surveyed report being pressured to “low-ball” earnings estimates or inflate their stock recommendations: clear evidence that Wall Street still has much work to do to regain the trust of investors.

The Stuff of Legends

Benjamin Graham, Warren Buffett, Charlie Munger, and Martin Whitman are legendary value investors whose wisdom is enduring. Munger was neatly profiled in CFA Magazine earlier this year. Here are videos featuring timeless advice from all four investors:

In Memoriam

Bob Haugen, the father of low-volatility investing, passed away January 6, 2013.

Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

About the Author(s)
David Larrabee, CFA

David Larrabee, CFA, was director of member and corporate products at CFA Institute and served as the subject matter expert in portfolio management and equity investments. Previously, he spent two decades in the asset management industry as a portfolio manager and analyst. He holds a BA in economics from Colgate University and an MBA in finance from Fordham University. Topical Expertise: Equity Investments · Portfolio Management

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