The stock market as measured by the S&P 500 recorded very powerful results in 2013, advancing 32% (total return), the best performance since 1997. Other equity indexes advanced strongly, confirming that a sustainable economic recovery has begun. The 10-Year U.S. Treasury Bond rate ended the year at 3%, up significantly from the 1.4% Iow recorded in 2012. The rise in rates suggests a strengthening in credit demands normally associated with an upturn in economic growth. None of this is very comforting to bond holders, who experienced a loss of 3.2% (according to the Bloomberg U.S. Treasury Bond Index) in U.S. Treas­uries in 2013. Financial markets are a leading economic indicator and the strong equity gains of 2013 hopefully are a predictor of better economic times in years ahead.

Solid evidence of a strong recovery from the Great Recession of 2008 – 2009 has remained elusive for more than three years. One decent quarter of economic growth seemed always to be quickly followed by a disappointing report in the subsequent quarter. The recovery just could not seem to establish a consistent momentum associated with past cyclical recoveries. As the accompanying chart (next page) shows, this is the most modest recovery in the post-World War II period. This fact is despite the Federal Reserve’s stimulus policies that have been pursued relentlessly since 2008, longer than any time since the organization’s founding in 1913.

Lately some very positive economic results have been reported. Third quarter gross domestic product rose 4.1%, the first quarterly result above 4% since Q4 of 2011. Unemployment rates have fallen to 7.0%, the lowest since 2008, but are still above the Fed’s minimum acceptable rate of 6.5%. The inflation rate has steadied at 1.2%, under the Fed’s 2% target rate. Gold prices, another indicator of inflation, fell to a four-year low of $1,193 an ounce from a high of $1,907 in 2011, suggesting the inflationary doomsdayers are premature. Also, consumer confidence continues in an uptrend.

The degree of monetary stimulus is evident in the growth of the balance sheet of the Federal Reserve bank. From about $900 billion in assets in the spring of 2008 before the financial crisis, the Fed balance sheet has now ballooned to over $4 trillion, up 400%, a growth rate vastly above the financial and monetary needs for the modest recovery to date. Much of the excess liquidity has flowed into the financial markets, resulting in a secular decline in interest rates and a sharp advance in both stock and bond prices.

Overall, it was a bad year for the President and Congress. Public approval ratings of both the Legislative and Executive branches of government fell to very low levels as global issues have continued in Iraq, Afghanistan, Egypt and elsewhere in the Middle East. A surprising breakdown in U.S. relations with Saudi Arabia, a key ally in the region, spilled into the open. As a show of protest, the Saudis declined to accept a long-sought seat on the Security Council of the United Nations. Former Saudi Ambassador Turki al-Faisal, nephew of the King and former Clinton classmate (and close friend) at Georgetown University, publicly questioned the U.S. positions with respect to Iran, Syria, and Yemen. Public disagreements among long-standing allies are extremely rare and given our economic interest in Middle Eastern oil, these developments are a threat to world economic stability.

For the first time in over forty years, the possibility of energy independence is at hand. With the growth in the United States’ output of shale oil and natural gas, crude oil production posted the largest year over year increase in volume since 1859. Domestic energy independence was a national goal first articulated by Richard Nixon in the fall of 1973 in the aftermath of an oil embargo imposed by OPEC in retaliation for U.S. support of Israel in the Yom Kippur War in October of 1973. A national energy policy was never adopted, and some would say the government policies directly thwarted the national goal of energy independence. Eventually the free markets that were shackled by government regulations broke free, and now we can see a domestic energy future free of foreign threats to our economic security.

Today we confront a threat to our economy brought on by a new and forceful attempt to implement a national health care program. Efforts to provide a national health care system began in 1945 with President Truman’s proposal for such legislation, which was based on the Western European model. This model traced its beginnings to the 19th century German Chancellor Bismarck. Prior to President Obama’s Affordable Care Act, only senior citizens and the economically disadvantaged were covered by national programs. The over-65 group was covered by the Social Security Amendment of 1965 (Medicare) and the lowest income categories were covered by state programs known as Medicaid. The next serious attempt to provide national health care was proposed by President Clinton in the fall of 1993. Authored by then-First Lady Hilary Clinton, “Clinton Care,” as it was called, was quickly swallowed by various congressional committees and the whole effort died a year after it was unveiled. Another Democratic president, President Obama, successfully fought for and passed “Obamacare,” a far more comprehensive and far-reaching effort that passed through both houses of Congress without a single Republican vote. The bill, designed to be implemented over several years, impacts 18% of the entire U.S. GDP. The rollout of the bill to date has experienced many unexpected delays and more difficulties are no doubt in store, if only because of the size and complexity of the health care sector in the U.S. economy. The continuing consequences of the Affordable Care Act’s rollout will remain uncertain for the balance of this year and may impact our economic outlook.

Ignoring for the moment the health care challenges to this year’s economy, the outlook for 2014 is reasonably good. Residential construction spending is advancing at a 16% rate, supported by residential building deferred during the recession that resulted in significant pent-up demand for housing. Deferred auto sales that were similarly caused by the recession have resulted in the oldest auto fleet in history, now averaging eleven years. Deferred demand should support strong auto sales for several years. Another possible bright spot for 2014 will be the growing requirements to restore the nation’s infrastructure of bridges, roads, water systems and other capital needs for an advanced economy. Further, we anticipate coming strength in non-residential construction associated with commercial building and capital spending on plants necessary to increase manufacturing capacity. Finally, there are signs that a long period of exporting both jobs and manufacturing operations abroad is ending and the “reshoring” of the manufacturing base of this economy is occurring. Technological advances and the high transportation costs of imports are restoring cost advantages to the North American market as new plants from Caterpillar and Whirlpool are being relocated to the U.S. from abroad.

Although the Fed has pumped over $3 trillion into our financial system, the modest recovery to date has not triggered a surge in inflation rates. We believe a pickup in business in 2014 will not initially be accompanied by an increase in inflation, which together should enable 3-4% real growth in GDP. Such growth would likely come in tandem with a 7-10% increase in corporate profits.

With the S&P and Dow recording all-time highs, there is much speculation that the stock market is due for a correction. Corrections, defined as when the stock market declines 8 to 15%, can occur for numerous reasons. These include corporate earnings disappointments, poor economic performance, an external event involving an essential government/country, or a valuation correction that entails stock valuation multiples that have deviated far from the mean, as occurred during the tech bubble in the early 2000s. Often when an event is anticipated, the occurrence is delayed. In 1996, former Fed Chairman Alan Greenspan delivered his famous “Irrational Exuberance” speech, asserting that investors had driven up stock prices to unsustainable levels. The market was to shrug off his warning and surge 33% in 1997, beginning a four-year boom in tech stocks, showing that Greenspan’s conclusions were premature.

More recently, many believed that stocks could fall when the Federal Reserve announced they were beginning to taper Quantitative Easing, as the fear of a taper last June resulted in a market decline of 5%. What was surprising was when the Fed announced the real tapering in December, the market yawned and posted its second best day of the year, with the Dow advancing 293 points.

Fed watchers will have much to observe this year. Mr. Bernanke will end his eight-year run as Chairman of the Federal Reserve board and will be succeeded by Janet Yellen on February 1. A long time governor of the Federal Reserve, Yellen appears to be a safe choice and an orderly transfer of control of the central bank should be welcomed by the markets.

We believe interest rates will be fairly stable in 2014 with an upward bias in the 10-Year Treasury bond. In the near term, shorter maturities patterns of up to 3 years should experience higher rates as commercial bank loan demand picks up with the recovery in the economy.

A potential positive surprise this year could be better corporate profitability resulting from higher employment rates brought on by an increase in consumer spending, leading to a recovery in real consumer final sales – the key missing ingredient in the recovery to date. We are estimating a 5% improvement in the 2014 Dow earnings to 1,100. Applying a 16 to 17 price-to-earnings multiplier to this year’s earnings estimate, we would expect a Dow of 17,600 – 18,700, or about 6-13% higher than present levels. Adding 2% for dividends, we estimate that the total return for the year could be 8-15%.

During the year, our firm made a number of organizational changes that will strengthen our company and position us for future growth. Charles A. “Chad” Meyer, Jr. joined the firm as President on November 1, 2013. Chad, a graduate of Washington & Lee University and the NYU Stern School of Business, will oversee our company-wide marketing efforts. Steven Shea, our former President, will assume the position of Vice-Chairman and will focus his efforts on developing alternative opportunities arising from recent tax law changes. In addition, Edward G. “Ted” Hart, IV joined the firm as an Investment Associate, adding to our resources in this important area.

And so we enter 2014 optimistically, looking for continued economic expansion in both the U.S. and global economies. Accompanied by stable financial conditions, these expansions should enable higher global equity prices and relatively stable bond prices. We appreciate you, our clients, who have staunchly supported us during the difficult times of the last several years and now we look forward to better financial and economic times that we see on the economic horizon.