If you fell asleep January 1, 2011, and woke up December 31, 2011, you would think we had a boring year. For those twelve months, the S&P 500 rose 0.04 points (or 0% return). When you add dividends, the S&P 500 gained a 2% return for 2011.
You would have slept through a very busy year:
- Triple-digit swings of 104 trading days on the Dow
- A spread between highs and lows of 3.9% per day on the S&P 500 in August
- Fretting about government default because of political bickering
- Downgrade of the U.S credit rating
- European Union’s distress (International developed country index was – 12%; emerging market index – 19%)
- Arab uprisings with regime changes in Egypt, Tunisia, and Libya
- Continued tensions over nuclear programs in Iran
- The Japanese tsunami tragedy and nuclear meltdown
- Regime change in unpredictable North Korea
You would have missed other sensational headlines:
- U.S. unemployment rate declined from its high of 10% down to 8.6% in December—its lowest level in three years
- Factory output rose
- Consumer spending was strong
- U.S. was a net energy exporter (the first time in decades)
- Corporate profits continued their upward trend
The flight to quality reduced interest rates even further, making government bonds the best performer in 2011.
Usually, markets are driven by earnings and interest rates. Last year, political risk had the biggest impact.
No one will argue that the deficits need to be reduced. The issue is how to do it. Dr. David Kelly, Chief Strategist for JP Morgan, discussed his concern with how the deficit is cut.
Deficits are often discussed as a percentage of Gross Domestic Product (GDP). It was 8.7% the last fiscal year (government fiscal year is October 1 to September 30) and he anticipates 2012 to be 7.1%.
He is worried there will be a sharp decline in fiscal 2013 to 4.7% of GDP if the Bush tax cuts, payroll tax, AMT, and Medicare adjustments all expire in 2012. When there is a sharp drop to the deficit versus a gradual one, there is a huge drag on the economy because of the combination of increased taxes and spending cuts. Unemployment would also rise.
A gradual decline allows the economy to slow and absorb the changes as opposed to a potential recession with a suddenly slowed economy.
Although there are some attractively valued investments, we still anticipate continued volatility in 2012 with so many issues in the U.S. and Europe unresolved.