As I recently summed up our returns in 2013, now rolling into 2014, here are my brief thoughts on investing in the New Year:

Valuations

Stock market valuations are on the high end, like the mid-2000s, yet not bubble-grade like 1999. This should generate lower returns over the next five years, perhaps a 3-6% annual total return range with dividends on the S&P 500, depending on which valuation we end up with. 

This will be a risky five-year stretch, with 20% drops possible at the first sign of any economic hiccup, foreign or domestic. Without bubble-grade stock valuations or underlying large-scale economic problems like real estate speculation, 50%+ stock drops are less likely than they were during past peaks, yet always possible.

Although I don’t want to join the "This time, it's different” crowd, or even the "Stocks for the long run" crowd, I don’t foresee stocks returning to historical (lower) valuations from the last 100 years for long-time periods, ever . 

Forever is a long time, but if   you see valuations go lower than they've been in the past 30+ years, as they did in 2003 and 2009 (however briefly,) you should jump on that opportunity. Maybe we’ll get that one-in-a-hundred-year depression crash of over 75% in all stocks again, but it’s not likely enough to wait for. 

Small-cap stocks are at what will be unrewarding levels for investors. This observation is a little too common for it to be spectacularly prescient, but unless the market keeps going up by double-digits each year so that small stocks can continue to beat big stocks, these smaller stocks will likely deliver 2% per year less  in total returns than the S&P 500, and 10% less in a stock market that declines more than 10%. You’re taking more downside risk for very little upside advantage. I’ll leave it at that.

As noted recently, some areas of the Internet, notably the digital advertising space (the fact that we’re using the word "space" is already bubble-grade talk) aren't going to reward investors as a group from current valuations. Biotech stocks, having  recently been discovered by investors after a multi-year hot streak, also merit a warning. Former holding SPDR Biotech XBI won’t be back in our portfolios any time soon.

Bonds

The recent rate rise should continue to stall out at around 3% on the 10-year government bond. We just don't have  the inflation or economic conditions to warrant significantly higher rates for long periods of time. The threat of a new slowing of the economy and yield demand by aging boomers will keep rates from going to even year 2000 levels.

More specifically, high-credit-grade bonds are the better place to be after significant outperformance and investor interest in lower-grade corporate bonds (junk bonds) and convertible bonds.

Even more specifically, over the next few years, shorter-term rates could climb to more normal levels, leaving long-term bond investors (normally those at risk for a big hit if rates rise) with minimal losses after adjusting for the higher yields of these bonds. This means an investor in short to mid-duration bond funds could underperform an investor in "risky" long-term bond funds over the next year (and beyond,) even with rising rates. Mostly beyond.

The main reason this curve may flatten or even go inverse way down the road is the money betting on the short end and the fact that the lonely investment rarely loses to the crowded investment. 

Foreign v Domestic

Foreign stocks are now cheaper than U.S. stocks across the board. This doesn’t matter much, because they always should be. No country has the combination of industry diversification, corporate innovation, and investor safety that we do, and all deserve to trade at a discount to our market. The mid-2000s, when investors bid up foreign stocks, was the fluke – not the future. 

That said, at some point, cheap bests opportunity. An emerging markets investor in the year 2000 fared better than a U.S. growth stock investor. We're probably close to a fair tradeoff in valuation discount now. The main reason not to go whole hog abroad is the troubling continued interest in such diversification by investors despite years of underperformance to the U.S. stock market. These aren't primarily value investors buying the cheaper dollar of earnings, either. They believe in blanket global diversification for diversification’s stake (and many own a few percent in gold, because, hey, why not? Lowers portfolio risk, right?) and/or are American declinists who feel America's somehow still on economic thin ice. 

Bottom line – most countries are in worse shape than America. Our portfolios grew heavy enough in foreign markets in recent years – during various panics and streaks of underperformance in foreign stocks, when good sense also said to wait until the mutual fund investor leaves the building.