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2013 was the year of unstoppable stocks

Published: Tuesday, Dec. 31, 2013 1:03 p.m. CDT • Updated: Tuesday, Dec. 31, 2013 4:11 p.m. CDT

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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 good year to wear noise-cancelling headphones," said Dean Junkans, chief investment officer for Wells Fargo Private Bank. "There were a lot of things that happened and the market kept moving higher."

The Standard & Poor's 500 had its best year since 1997, ending up 29.6 percent. The Dow Jones industrial average also turned in a stellar performance: It closed up 26.5 percent, its best gain since 1995. Combined, the two indexes closed at record highs on 97 occasions.

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 are forecast to increase 5.37 percent, to a record $109.03 a share, according to data from S&P Capital IQ.

"It's tough to argue that companies are in anything other than good health," said Paul Atkinson, head of North American equities at Aberdeen Asset Management, a global fund management company that oversees about $3 billion.

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 10 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 U.S, 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. This year, bonds in the index handed investors a loss of 2 percent, the first loss since 1999.

As the economy improves, many investors believe that interest rates will continue to rise and bonds will only fall further.

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?

A stock rally doesn't need to be loved

Signs of euphoria largely were absent from the stock market, despite the big gains. In fact, the market seemed out of step with a fragile economy.

The pace of mergers and acquisitions lagged as executives remained unwilling to strike large deals amid uncertainty about the economy. Corporate profits rose, but largely due to cost-cutting, not higher sales. Hiring picked up, but at a sluggish pace.

"I've never seen a near 30-percent year where investors are so unhappy," said Jonathan Golub, chief U.S. market strategist at RBC Capital Markets.

Investors put $77.6 billion into U.S. stock funds in the first 11 months of the year, according to Lipper fund data. The last time investors put more money into stocks than they took out was 2005. But the inflows were only a trickle compared with the $451 billion withdrawn from stock funds between 2006 and 2012.

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 Renaissance Capital data.

Hotel chain Hilton Worldwide and social media site Twitter went public. In total, companies sold $61 billion of stock in 2013, as of Dec. 17, an increase of 30 percent from 2012.

In the years that followed the financial crisis and the Great Recession, a volatile stock market made listing new companies more difficult, said Scott Cutler, head of global listings for the New York Stock Exchange. The smooth ascent of stocks in 2013 ensured that the market for IPO's stayed open all year.

"I expect the environment to continue as we have seen it in 2013," Cutler said. "Investors have been making money in equities again."

Change is constant

The 30-member Dow got a makeover in September, swapping out three old members for three new ones. It was the biggest shake-up for the blue-chip index in almost a decade. Out went aluminum producer Alcoa, Bank of America and Hewlett-Packard. In came Nike, Goldman Sachs and Visa. Despite its name, the Dow Jones industrial average is no longer dominated by industrial companies and now contains financial firms such as JPMorgan and Travelers, as well as retailers like Home Depot and Wal-Mart, reflecting the changing nature of the U.S. economy.

Europe is getting better

Jitters about Europe subsided. In 2012, concerns about the health of the banking systems in Spain and Italy weighed on U.S. stock markets. In 2013, despite some flashbacks – worrying Italian elections in February and the collapse of the Cypriot banking system in March – investors didn't panic.

There's always a glitch

A technical glitch halted trading on the Nasdaq for three hours in August, embarrassing the stock exchange that hosts the biggest names in technology, including Apple, Microsoft and Google. Though less alarming than the "flash crash" of 2010 that set off a stock market plunge, it once again raised questions about the pitfalls of the electronic trading that now dominates stock exchanges.

The glitch in August was the most notable of 2013 for the Nasdaq, but not the only one. There were brief outages in September and November.

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 the year at 2.17 percent, higher than the 1.76 percent yield on 10-year Treasury notes.

Utilities and phone companies, traditionally big dividend payers, began the year strongly as investors sought steady stocks with bond-like characteristics. Utilities companies in the S&P 500 surged 18 percent in the first four months of 2013 before Treasury yields started rising, curbing their appeal.

Companies are also taking note of investor's desire to see dividend payments. 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," said Liz Ann Sonders, chief investment strategist at Charles Schwab & Co.

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