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Market Insight - Year End 2011

Last year financial markets delivered a proverbial rollercoaster ride to investors. While a year end Santa Claus rally was enough to undo much of the damage, the view in October seemed very grim, and we looked much more likely to go right off the rails, than to end up where we did. 

The positives we looked for a year ago; easing business credit, slowly strengthening job creation, an increase in mergers and acquisitions activity (in the first half), and stronger consumer spending, all helped to move stocks forward during the first six months, but markets were blindsided by the political brinksmanship and legislative gridlock that led to the summer downgrade of US debt. This was compounded by a worsening Euro crisis, and significant downward revisions of US GDP growth.  The quarter ending September 30th, when the S&P 500 lost 14%, was the worst quarter since the end of 2008. Yet, an unexpected and robust  recovery in US stock prices over the last three months has pulled US markets a little ahead of where they started in January.

The Numbers

The Dow posted a total return of 8.38% in 2011, while the S&P 500 advanced 2.11%. The S&P Mid Cap 400 fell 3.1%, while smaller stocks, measured by the S&P  Small Cap 600, slipped  2/10 %. Gold slumped 17% from its 2011 high, but still managed to post a 10% gain for the year. Global stock markets were hit particularly hard by uncertainty over European debt; the MSCI Emerging Market index fell 20%, while the MSCI Developed Markets index lost 14.9%. Investment real estate and bonds were among the best performing asset classes, fueled by better than expected consumer spending, low interest rates and a flight to safety. Cohen and Steers Realty fund gained 6.18% for the year, US treasuries added  9.78%, Corporate bonds rose 5.16%, while high yield bonds gained 3.14%. Tax free municipal bonds also were up over 10%, as fears of a muni meltdown receded. The best performing sector in US equity markets was Utility stocks, with a 15.6 % gain; the worst; financials, with a 17.3% loss.

Will US Markets Decouple from Eurozone Concerns?

Temporarily, the Euro crisis has cooled off a little, and the Eurozone has pulled back from the threat of complete collapse. However, the challenges of a common currency and independent fiscal policies are far from being met.  It is tempting to criticize the European Central Bank and the sovereign nations for their half hearted, ineffective measures, yet the loss of national control of a country's  fiscal agenda is extremely traumatic, even for economies that have gotten into such deep trouble. Greece remains in danger of abandoning the Euro, and this could shock markets in 2012. Still, we think that the markets have priced a year of zero growth,  even a mild recession into European stocks, and despite the current concerns we look for above average 2-3 year returns to investors in global markets.  One wild card; a deeper than expected recession in Europe could blindside both US and Chinese export strength, and could pose the most serious risk to global recovery.

2012 may see a modest rise in yields and muted returns on bonds, but we think investors will be surprised on the upside in stocks, driven by lowering unemployment, stronger output in the manufacturing sector and rising earnings in excess of expectations.

The unemployment rate has fallen to 8.65% from the mid 9% levels in 2011, and initial jobless claims, a leading indicator,  are very slowly improving (see below).and are at a three year low.

Manufacturing grew in December at the fastest pace in six months and hiring at U.S. factories picked up. The Institute for Supply Management, a trade group of purchasing managers, just released the November manufacturing index, which rose to 53.9 from 52.7.  Readings above 50 indicate expansion.

S&P 500 companies have beaten Wall Street profit estimates for 11 straight quarters. An average of 73 percent of corporations in the index exceeded analysts’ estimates in the first three quarters of 2011, with earnings-per-share topping projections by 5.3 percent.

Steven Weber

Investment Advisor, Principal

The Bedminster Group

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