Your Money: The Top Story of 2013

What event during the past year had the greatest effect on your financial fortunes? Gordon Pape’s answer may surprise you.

There are several candidates for the biggest financial story of 2013. The BlackBerry collapse. The improbable resurgence of the Tokyo stock market. The dramatic fall in the price of bullion and its impact on the shares of gold mining companies, which collectively lost more than half their value. The rebound on Wall Street.

You could make a case for any of these but to my mind the most important story of the year was one that never happened – at least, not at the time.

It goes back to the third week in May. The U.S. markets had been on a steady climb since the start of the year, with the S&P 500 closing in on 1,670. Then word started spreading on Wall Street that the Federal Reserve Board was about to start winding down its quantitative easing (QE) program, which was pumping US$85 billion a month into the economy. Investors were rattled and the markets started to drift lower.

A few weeks later, Fed Chairman Ben Bernanke confirmed the speculation, saying that the “tapering” process would start later in the year and that QE would likely end entirely in 2014. Investors immediately hit the sell button, with the Dow and the S&P 500 recording their worst one-day losses since 2011. By the time the sell-off was done, the S&P had lost almost 6% from its May high.

What they failed to realize was the close relationship between their investments and interest rates. The market is always balancing risk and return. When yields on Treasury bonds start to rise, smart investors demand a better return from higher risk securities to compensate. So while a 4.5% yield on a REIT might be acceptable with 10-year Treasuries paying 1.76%, it’s nowhere near enough when they’re offering 3%.

Absent a distribution increase, the only way yields on REITs can move higher is if the price drops, and that’s exactly what happened. The S&P/TSX Capped REIT Index lost 10.6% over the year, while utility stocks were down 8.9% and preferred shares 7.2%.

Finally, six months after the spring sell-off, tapering has finally been confirmed and will start this month. Ironically, the markets greeted the news by moving higher.

But this rising tide isn’t lifting all ships. Interest-sensitive securities will struggle in 2014 as upward pressure on rates continues. This means defensive investors will have to change their whole approach or risk experiencing more damage to their portfolio.