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BBVA Compass

Quarterly Market Update

Equity Outlook

Strong Broad Equity Market – What a Change in the 10-Year Results

Every day as investors focus on stocks, there is a constant struggle between the Bulls and the Bears. In this 24/7 world, data dependency has become commonplace and the long-term view is too often viewed in days, not years. We all fall into this immediacy trap, but it is extremely important to take a step back and make sure we expand our time horizons. At the end of 2010, a common refrain was “stocks have underperformed for a decade” and the new normal was that stocks are no longer the assets of growth. As Figure 2 highlights, this line of reasoning has been seriously challenged.

In 2013, the broad market averages experienced significant appreciation growth. This improvement occurred despite the markets’ early 2013 concerns about the fiscal cliff, sequestration, the implementation of the Affordable Care Act, higher than normal unemployment levels and concern about pending Federal Reserve (the Fed) taper efforts. The negatives did not go away in 2013 but the positives of continued corporate earnings growth, moderate pickup in the real estate markets, lower fuel costs and the maintenance of global monetary conditions appear to have outweighed the negatives.

As reflected above, not only was 2013 an outstanding year for the broad market averages, the returns for the longer term periods are impressive.

Equity Chart 1

Figure 1. Broad equity market returns achieve double digits for the one- and five-year periods.

Whenever the equity markets have strong positive or negative movements, investors always ask ‘what is the next likely change of direction’? Certainly, as 2014 has begun, we have witnessed both up and down days in the equity markets. Some believe all of the good news is in the market, valuations are at levels where sustainability is difficult and the effects of the Fed taper will create a difficult environment for stocks.

While one acknowledges these concerns, we submit 2014 is more likely to be a year that stocks continue to outperform both fixed income and cash returns. Yes, as the taper process unfolds, general interest rates will rise. Based on current Fed announcements and given the events of last May, we expect the Fed to proceed in a careful measured way to avoid major market disruption and rapidly rising rates. Also, the total liquidity of corporations continues to remain at above normal levels as most corporations have remained diligent in their efforts to rebuild balance sheets and maintain cost controls. In 2013, price/earnings multiples did expand, providing the underpinning for much of the equity market’s performance.

However, we submit the increase in the multiples is more of a return to the mean as opposed to a change to excessive or unreasonable levels. With consensus S&P 500 2014 earnings growth forecast at seven to eight percent annualized, we believe the broad equity markets continue to offer attractive risk and reward characteristics.

Equity Chart 2

Figure 2. A comparison of price-to-earnings ratios and earnings-per-share across capitalizations and developed and emerging countries.

BBVA Compass is the trade name for Compass Bank, which is a member of the BBVA Group. Securities products are NOT deposits, are NOT FDIC insured, and are NOT bank guaranteed. May LOSE value, are NOT insured by any federal government agency.

This material contains forward looking statements and projections. There are no guarantees that these results will be achieved.

Investing involves risk including the potential loss of principal. There is no guarantee that a diversified portfolio will outperform a non-diversified portfolio in any given market environment. No investment strategy, such as asset allocation, can guarantee a profit or protect against loss in periods of declining values. Past performance is no guarantee of future results. Please note that individual situations can vary. Therefore, the information presented here should only be relied upon when coordinated with individual professional advice.

Indexes are unmanaged and investors are not able to invest directly into any index.

International investing involves special risks not present with U.S. investments due to factors such as increased volatility, currency fluctuation, and differences in auditing and other financial standards. These risks can be accentuated in emerging markets.

Investments in stocks of small companies involve additional risks. Smaller companies typically have a higher risk of failure, and are not as well established as larger blue-chip companies. Historically, smaller-company stocks have experienced a greater degree of market volatility than the overall market average.

Equity investments tend to be volatile and do not involve the guarantees associated with holding a bond to maturity.

In general, the bond market is volatile as prices rise when interest rates fall and vice versa. This effect is usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.

Fixed income investments are subject to various risks including changes in interest rates, credit quality, inflation risk, market valuations, prepayments, corporate events, tax ramifications and other factors.

The investor should note that vehicles that invest in lower-rated debt securities (commonly referred to as junk bonds) involve additional risks because of the lower credit quality of the securities in the portfolio. The investor should be aware of the possible higher level of volatility, and increased risk of default.

Municipal bond offerings are subject to availability and change in price. If sold prior to maturity, municipal bonds may be subject to market and interest risk. An issuer may default on payment of the principal or interest of a bond. Bond values will decline as interest rates rise. Depending upon the municipal bond offered, alternative minimum tax and state/local taxes could apply.

The price of commodities is subject to substantial price fluctuations of short periods of time and may be affected by unpredictable international monetary and political policies. The market for commodities is widely unregulated and concentrated investing may lead to higher price volatility.

Investments in real estate have various risks including possible lack of liquidity and devaluation based on adverse economic and regulatory changes.

Other Sources: Bloomberg;;; First page index returns are calculated on a total return basis using the following indexes: S&P 500 (SPX), MSCI World (MXWO), MSCI Emerging Markets (MXEF), Bloomberg 7-10 Year U.S. Treasury Index (USG4TR), Morningstar U.S. Agency Bond TR Index (MSBIUATR), Municipal Bond Buyer 40 Index (BBMIRNEW), Credit Suisse High Yield Index (CSHY), MSCI U.S. REIT Index (RMZ Index).