2012 Investment Outlook
Even though the majority of analysts are once again proclaiming that all will be well in the financial markets and that investors should expect outstanding returns in 2012, I am (once again) unconvinced. Serious questions remain about both the existence and depth of the purported economic recovery nationally and globally. I am also concerned about the extent to which the economy and the markets have been propped up via government action, inaction and intervention both here and overseas.
For a true recovery to take place we need changed behavior at the governmental level and at the individual level too. Without serious and significant change, something has to give. Because I am skeptical that significant change will happen or will happen soon enough, I cannot join the ranks of the bulls. But that does not mean we have to close up shop. Opportunities exist even in bad times. Sometimes, the best opportunities come up during the worst times. I encourage investors to be skeptical, cautious, and defensive yet opportunistic. In 2012, as in 2011, I suggest that they look to take advantage of the opportunities that present themselves while carefully managing and mitigating risk.
II. 2011 Results
When 2011 dawned, optimism ruled the day. Most “experts” called for a strengthening economy and healthy stock markets. The major investment firm predictions suggested an expected return on the S&P 500 index for 2011, which opened the year at 1,257.62, in the range of 10-12%.
I wasn’t so optimistic – not by a long shot.
In my 2011 Investment Outlook, published on January 5, 2011, I provided my view of the markets:
“Even though the majority of analysts are proclaiming that all is well in the financial markets and that investors should expect outstanding returns in 2011, I am decidedly less sanguine.”
That outlook led to the following advice:
“I …encourage investors to remain skeptical, cautious, defensive and opportunistic. In 2011, investors should look to take advantage of the opportunities that present themselves while carefully managing and mitigating risk.”
My view has been vindicated by what has happened in the economy and the markets, and it remains my view today. A change in the calendar does not mandate a change in outlook.
Although 2011 started off on a relatively strong note for the global economy and markets, it was dominated by fear. Overall global economic growth struggled as most areas of the world experienced growth slowdowns. Emerging markets were also faced with mounting inflation pressures, which presented a challenge for policymakers and investors. Although there have been some signs of progress regarding the worldwide debt crisis, uncertainty levels remain high and this issue will no doubt remain of paramount importance in 2012. Given this backdrop, risk assets struggled through 2011 as the year saw a renewed flight-to-quality theme.
The U.S. economy (pending final data) saw growth of about 1.7% for the year, down from 3.1% growth in 2010. Consumer price inflation should end up at around 3.5%, while unemployment trended slightly downward all year, and ended the year at 8.5%, even as the ranks of those who are underemployed or who have decided to give up on their job searches continued to grow. Many experts see a very real recovery continuing, albeit very slowly. Total debt in the U.S. economy, both public and private, peaked three years ago as a percentage of GDP, at 355%. It is now back down below 320% and declining slowly but steadily in a necessary deleveraging process, even as U.S. government debt outstanding continues to hit new record highs.
This fearful psychology and “ho-hum” economics are reflected in market returns.
As shown above, the S&P 500 Index closed 2011 at 1,257.60, down 0.003%, about as close to unchanged as possible and the smallest annual change ever recorded. At its peak in April, the S&P had climbed more than 8%. But by October, at the lowest levels of the year, it was down more than 12%, before rallying into December. Despite the index being flat for the year, investors owning an S&P 500 index fund saw positive nominal returns for the year on account of dividends. However, those gains were eaten up by inflation. Moreover, as shown below, 10-year real returns have also been negative.
Most investors were happy to see 2011 end. From unrest in the Middle East, slower growth in China and Japan’s devastating earthquake to Europe’s worsening debt crisis to the ongoing gridlock in Washington, stocks experienced violent swings. The Dow Jones Industrial Average, where underperforming financial stocks carry less weight, rose 5.5% for the year, while the tech-dominated NASDAQ lost 1.8%.
Meanwhile, international and emerging market stocks suffered a lot. In Europe, the year was dominated by the Eurozone debt crisis as all three major indexes ended the year in the red. Britain’s FTSE 100 index lost 5.6%, while Germany’s DAX and France’s CAC 40 dropped more than 15%. In Asia, the Nikkei tumbled 17%, while the Shanghai Composite and Hang Seng sank more than 20%.
While equities had a lousy year and have been generally poor investments over the past decade and more, the flight-to-quality theme meant that U.S. Treasuries logged their best gains since 2008, according to the Bank of America Merrill Lynch U.S. Treasury Master index, which returned almost 10% for the year. Yields on the benchmark 10-year note ended the year trading at 1.87%, down from 3.29% at the end of 2010. The broader bond market also did well – the Vanguard Total Bond Market Index, for example, returned in excess of 8%. Significantly, for the first time ever, 30-year bond market returns outpaced 30-year stock market returns.
Oil closed out the year trading at just under $100 per barrel, up over 8% in 2011. Gold closed out trading well in excess of $1,565 per ounce, reflecting an increase of more than 10% in 2011 and general investor skittishness.