As we enter 2014, we pause to reflect on 2013 and to comment on market events during the year. Developed equity markets continued to gain strength in Q4, as markets responded to indications of improving growth and continued accommodative monetary policies by central banks around the world. The global economy as a whole has shown steady upward growth trends in 2013, despite the relatively low absolute levels of growth. The year was particularly challenging for risk conscious investors as equity returns far outpaced other asset classes.
In 2013, domestic equity performance was the strongest in well over a decade. The S&P 500 was up 10.5% in Q4 and 32.4% for year. With corporate earnings growing approximately 6% in 2013, 75% of the appreciation during the year was due to P/E multiple expansion. That being said, we feel that current valuations are still reasonable at 15.6x 2014 projected earnings. Data shows that U.S. GDP grew at an annually adjusted 4.1% in Q4, comfortably beating estimates of 3.6%. For the first time in several years, there are no major issues hanging over the markets as we enter the new year. While P/E multiple expansion drove the strong returns of 2013, we project much more modest returns for 2014 driven by corporate earnings growth.
Despite continued slow growth, developed international equities posted strong returns for 2013. The MSCI EAFE index was up 22.8% for the year, being led by Japanese equities which were up 58.8% due to the drastic fiscal and monetary measures taken by the Bank of Japan. Equities in developed markets have been outperforming emerging market on a sustained basis for the first time in 10 years. The MSCI Emerging Markets index was down 2.6% for the year. In general this has been due to slowing growth in China, coupled with cyclical improvement in more developed countries. Additionally, the prospect of U.S. tapering has caused a rotation out of emerging market equities back into U.S. equities. Looking forward to 2014, we project strong returns from Europe as earnings continue to improve. In emerging markets, we think many of the issues plaguing these countries in the past year will continue in 2014.
Unlike developed economy equities, 2013 was a dismal year for bond markets. Beginning the year interest rates were close to historic lows, thus it was not surprising that rates spiked following the announcement in June that the Fed would begin tapering its quantitative easing program. The Barclays Aggregate index was down 0.75% in Q4 and 2.75% for the year. The 10-year Treasury increased from 1.8% on January 1 to 3.0% on December 31, its highest yield since July 2011. While longer-term interest rates have risen, short-term interest rates have remained largely unchanged for the year. This has created a “steepening” of the yield curve, which has typically been associated with market expectations of improved economic activity. Looking forward to 2014, we expect the Fed to continue its tapering program creating headwinds for fixed income.
During 2013, hedge fund returns were generally positive. The HFRX Aggregate index was up 7.4%. Short strategies, managed futures, and global macro struggled as equity markets surged during the year. Strategies with larger net exposures generally outperformed more hedged strategies. Looking forward to 2014, hedge funds are well positioned to take advantage of the future market environment. 2013 saw record inflows into hedge fund strategies, as investors continued to rotate out of fixed income strategies. Commodities investors had a disappointing 2013. The DJ UBS Commodity index was down 9.6% for 2013. While energy sectors were up 5.2% for year, the index was hurt by poor performance in precious metals (-30.8%), agriculture (-14.3%), and industrial metals (-13.6%). Real estate also lagged equity markets. The FTSE NAREIT index was only up 2.5% for the year. Real estate valuations were hurt in the second half of the year as interest rates spiked. For 2014, real estate markets are poised for strong performance as valuations are more attractive.