2013 a banner year for U.S. stocks

NEW YORK – The stock market was unstoppable in 2013.

A U.S. government shutdown, fear of a default, the threat of military action in Syria, big budget cuts, and a European country looking for a bailout – any number of events might have derailed the stock market. But they didn’t.

And if skittish investors jumped out of stocks, they lost out.

“2013 would have been a good year to wear noise-canceling headphones,” says Dean Junkans, chief investment officer for Wells Fargo Private Bank. “There were a lot of things that happened and the market kept moving higher.”

Instead of worrying about the wider world, investors focused on the Federal Reserve and the outlook for its stimulus program.

The Fed bought $85 billion in government bonds each month in 2013. The purchases were designed to hold down long-term borrowing rates and encourage spending and investment. The stimulus also prodded investors to move from low-yielding bonds to stocks.

Investors reacted to every twist and turn of the program’s fate. They sold stocks in the spring and summer over fears the central bank would slow its bond-buying prematurely. They worried that every bit of good economic news signaled the end of support. But in December, as hiring grew consistently stronger, investors were confident enough in the economy that they reacted positively when Fed officials finally decided to dial back purchases. The Fed also reassured the market by signaling it would keep short-term rates near zero. The stock market, which hovered below all-time highs, returned to record territory.

Of course, it wasn’t all about the Fed. Companies also played a part.

Despite a middling economy, U.S. corporate earnings rose for a fourth straight year. Total earnings for S&P 500 companies in 2013 were forecast to increase 5.37 percent, to a record $109.03 a share, according to data from S&P Capital IQ.

Investors, emboldened by the Fed’s support and low inflation, were willing to pay more for those earnings. The price-earnings ratio for the S&P 500 index, a measure of earnings compared to stock prices, rose to 15.4 from 12.6 at the start of 2013, according to FactSet data. By that measure, stocks grew more expensive, but aren’t necessarily overvalued. The P/E ratio remained below its 20-year average of 16.5.

Here are six lessons from the year of the bull:

Small companies can give big returns

Some of the best performers in 2013 weren’t the big blue-chip stocks, but smaller ones. The Russell 2000, an index that tracks small stocks, rose 37.1 percent, more than the Dow and the S&P 500. Smaller companies are more focused on the United States than larger multinational corporations. That means they benefit more when the U.S. grows faster than other parts of the world, such as Europe. That’s exactly what happened in 2013.

The bond party is over

Yes, they were safe, but with 10-year Treasury notes paying interest below 3 percent for most of 2013, bonds weren’t sexy. From 1981 to 2012, government and company bonds rose 35 percent, according to the Barclays Capital U.S. Aggregate Bond Index, a broad measure of the debt market. In 2013, bonds in the index handed investors a loss of 2 percent, the first loss since 1999.

Don’t wait for the dips

Even with all the unsettling headlines, 2013’s stock surge was achieved without a significant wobble. The S&P 500 has gone 27 months, since Oct. 3, 2011, without a correction, defined as a drop of 10 percent or more. That compares with an average streak of 18 months between such declines, according to S&P Capital IQ.

Investors who sat out the rally in stocks are left with a quandary: Do they buy now that stocks have become more expensive, or do they stay on the sidelines, waiting for a dip, and risk being left further behind?

The IPO market is back

The number of initial public offerings rose to its highest level since before the recession in 2007, according to data from Dealogic as of Dec. 17. It’s easier for companies to sell stocks in a climbing and steady market because investors are more confident they can make money.

The average IPO stock rose 35 percent in 2013, outperforming the S&P 500, according to Renaissance Capital data.

Dividends matter

Investors also focused on dividends as bond yields started 2013 close to record lows.

The S&P 500 dividend yield, which measures the dividend payment on stocks versus their price, started 2013 at 2.17 percent, higher than the 1.76 percent yield on 10-year Treasury notes.

Utilities, companies in the S&P 500, traditionally big dividend payers, surged 18 percent in the first four months of 2013 before Treasury yields started rising, curbing their appeal.

As of Dec. 20, 417 companies in the S&P 500 were paying dividends. That’s the highest number since 1998 when 418 companies were paying regular dividends.

Including dividends the S&P 500 returned 31.9 percent, and the Dow 29.1 percent.

The Fed matters more than Congress

While budget battles have rattled the markets before, investors started to get wise to Washington’s habit of wrangling until the last minute before reaching agreements on the budget and other fiscal policy.

In 2011, lawmakers shook financial markets when they argued about raising the debt ceiling and pushed the U.S. toward default. Stock markets slumped before a deal was reached at the start of August and then plunged further as the Standard & Poor’s rating agency cut the nation’s debt rating days later. The S&P 500 dropped 15 percent in a four-week period between July 20 and Aug. 10, 2011.

In 2013, investors stayed calm despite the first government shutdown in almost two decades and brinksmanship over the debt ceiling. After dipping briefly at the start of the shutdown, the S&P 500 rose 2.4 percent between Sept. 30 and Oct. 16, when a deal was reached to fund the government and avoid default.

“Not that Washington has yet become a positive, but I think that the bar got so low it was pretty much on the ground,” says Liz Ann Sonders, chief investment strategist at Charles Schwab & Co.