I don't understand some investors. The first several days of 2014 were a down note -- and in the eyes of many investors, that signaled the end of the bull market.
This kind of thinking is ridiculous in my book. What we have witnessed is profit-taking, pure and simple. Every new high is always greeted the same way -- with investors taking their profits before buying back into the market. It happens again and again, but each time -- particularly at an arbitrary milestone like the first of the year -- it brings fear to investors.
Every bullish stock market has periods of selling. A glance at the weekly chart of the Dow Jones Industrial Average shows a dozen down weeks during the super-bull market of 2013.
Fueled by strong corporate earnings and unconditional support from the Federal Reserve, the Dow surged more than 3,000 points higher last year. Stocks amply rewarded patient long-term investors with the foresight to stick to their investment plan.
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It was not just stocks that surged in 2013, as private equity firms also posted a record-breaking year. I expect this bullish trend to continue into 2014.
Once reserved for the ultra-rich and institutional investors, private equity is one of the engines that drive capitalism. These firms buy and sell public and private companies, helping to create value for shareholder and companies across the board. Private equity funds are estimated to have returned $120 billion to investors last year, beating 2012's record by $5 billion. Over $143 billion was invested in this sector, the most since 2008.
What's most interesting is that private equity firms are generally required to return money to their investors after 10 years. This puts the firms on a timetable to begin liquidating investments made during the buying frenzy prior to the financial crisis. In addition, a record 94 companies with private equity firm involvement went public in 2013. These IPOs raised more than $33 billion.
All this money has to go someplace -- and if you guessed it's likely to continue to flow into the stock market, you're right. This capital influx would continue to fuel the private equity explosion -- a win-win situation for stock investors and private equity investors alike. This is why I expect the private equity boom will continue well into 2014, creating an ideal environment for investors in this sector.
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One additional potential catalyst is the Volcker rule (part of the Dodd-Frank financial regulation act), which bars banks and traditional lenders from proprietary trading and participating in other high-risk activities with depositors' money. Private equity companies do not hold depositors' money and therefore could become the next powerhouse proprietary trading facilitators. If this occurs, private equity firms stand to book significant profits.
Exchange-traded funds (ETFs) are the optimal way to capture the continuing boom in private equity. They provide diversified exposure that mitigates the risk of investing in a single company while maintaining the profit potential of an often volatile sector.
My favorite ETF in this sector is Power Shares Global Private Equity Fund Portfolio (NYSE: PSP), which yields 13.6% and was up 37% last year. With close to $500 million in net assets, PSP seeks to track the Red Rocks Global Listed Private Equity Index, which comprises between 40 and 75 private equity firms, master limited partnerships (MLPs) and business development companies (BDCs). U.S. firms account for 42% of holdings, with the United Kingdom, France, Switzerland and Canada rounding out the top five countries by weighting. The three largest holdings are Blackstone Group (NYSE: BX), Onex (NYSE: OCX) and Kohlberg Kravis Roberts (NYSE: KKR).
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PSP has been trending higher since hitting a low just above $6 at the start of 2012.
Risks to Consider: Private equity, like all business activity, is governed by interest rates and global economic growth. A slowdown in global growth will negatively impact the performance of private equity investments. A bullish bet on private equity is essentially a bullish bet on the health of the entire economy. Always diversify and use stop-loss orders when investing.
Action to Take --> Buying PSP on a breakout close above $12.50 makes solid sense. I expect to see PSP trading above $18 within the next 12 months, which represents 50% upside from current levels.