Wow, what a year.
There were 53 hundred point or greater Upside days and 50 hundred point or more Downside days in the Dow Jones Industrial Average. That’s a ratio of over 40% of all the trading sessions for 2011; no wonder the investing public is frightened. Despite all that extreme volatility, the US equity markets held up remarkably well, with the S&P500 closing with the smallest price change in 41 years (0.04 points); the Dow gained 5.5% aided by McDonalds 31% gain, while the technology heavy Nasdaq declined 1.8% for the year. Even these rather paltry results placed the US equity market near the top of global stock market performance.
Unfortunately the same cannot be said for the international markets. European markets were clobbered amid the debt crisis with most countries posting declines well into the double digits. The Japanese market declined as they struggled to recover from the effects of a natural disaster and China declined roughly 20% as they implemented policies to slow the growth of their economy. Many emerging markets also posted sharp declines.
I think the reason for the resiliency in the US is that the panic declines of August (US debt ceiling debacle), and early October (European debt crisis), created the most oversold stock market readings in years, making it difficult for stocks to fall further. U.S. companies churned out record profits, and price-to-earnings ratios of stocks dropped to their lowest levels in recent memory. But that mattered little to investors. Here are some of the 2011 events that all but drowned out the stock market’s positive fundamentals and had investors shifting away from equities en masse:
- February – “Arab Spring” uprising in Egypt and Middle East.
- March – Japan earthquake/tsunami/nuclear crisis.
- August – US government debt downgraded after debt ceiling/deficit reduction fiasco in Congress.
- October – European debt crisis comes to a head as Greek bond holders take a “voluntary” 50% haircut.
With 2012 being a presidential election year I think it safe to anticipate no change in the partisan gridlock we experienced in 2011. I am not counting on any significant policy initiatives out of Washington to help stimulate employment or resuscitate housing. However, said gridlock may not be all that bad.
In spite of the charade put forth by our elected officials during 2011, the US economy continues to show improvement and is heading into 2012 with positive momentum. The last week in December 2011 was the 13th consecutive week with stronger economic reports. Even employment and housing are starting to show signs of life. Combine this with historically low interest rates and the historically high level of cash on the sidelines and I think the probability of the US falling back into recession is fairly low.
To me, the outlook for 2012 looks promising. However, 2012 could wind up being one long Groundhog Day and a repeat performance of 2011’s volatility would not be a surprise. Here are several things I am watching as we head into the new year:
- Policy Purgatory – Policymakers around the globe have largely failed to address long-term global issues and have instead opted for short-term measures “buying time”. Political maneuvering and resulting policies (US, Europe and China) will have significant impact on global economic growth. I do expect that improving conditions in the US and developing countries will offset an all but certain recession in Europe and keep the global economy growing.
- Inflation / Interest rates – Inflation will likely remain in check through 2012 allowing central bankers to continue a “cheap money” approach, holding interest rates at or near current levels. This will force retirees and large pension funds to look beyond traditional fixed income investments (CDs, Treasuries, bonds) to generate the returns they need to meet their obligations (which should be a positive for dividend paying equities).
- Wildcards – new leadership in North Korea and increasing aggressiveness by Iran are current wildcards. China is likely to assist in controlling N. Korea as it is in their best interest to keep things calm in that region. While Iran is more concerning and there is no “big brother” like China to keep it in control, any actual aggressive action on their part to interrupt shipping in the Gulf would be like shooting themselves in the foot. Iran is the 2nd largest oil exporter in OPEC and derives 80% of its hard currency earnings from exporting its oil and gas. Already under severe economic sanctions from US and Europe, they can ill afford to cutoff their own oil revenues.
- Unknowns – no one expected the “Arab Spring” or Japan tsunami this past year. What unknowns – man made or otherwise – lie ahead in 2012? Bear in mind not all unknowns are negative. Two perspectives on this – 2012 is the last year of the Mayan calendar and the Armageddon prophecy. It is also the Chinese year of the Dragon. “China’s celestial dragon symbolizes potent and benevolent power. Dragons are ancient, majestic, wise, and intelligent, and Dragon years also tend to boost individual fortunes and the world economy”. (paraphrased from Wikipedia)
Sources: Wall Street Journal, New York Times, Riverfront Investment Group, Advisors Capital Management
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