We entered 2011 with much hope and promise since the economy was showing signs of continued improvement. However, extreme volatility took over last year due to Japan’s Tsunami, Libya and other middle-east unrest, a spike in oil prices, Europe’s debt crisis resurfaced, fears of another recession lingered, Congress continued its dysfunctional ways and then the U.S. credit rating was downgraded. Through all this unrest, our economy showed tremendous resilience. Investors are pleading for a smoother and much calmer market for 2012. Unfortunately, we’re not likely to have that. Uncertainty continues so we’d expect more volatility in the markets.
Financial Market Indices as of December 31, 2011
Last 3 Months
Last 12 Months
|S&P 500 Total Return (US stocks)||1.0%||11.8%||2.1%||2.1%|
|MSCI Developed EAFE (foreign stocks)||-0.9%||3.4%||-11.7%||-11.7%|
|MSCI Emerging Mkt. Equities (emerging country stocks)||-1.3%||4.1%||-20.4%||-20.4%|
|Barclays Capital Aggregate Bond – Intermediate Term||0.8%||0.9%||6.0%||6.0%|
|Barclays Capital Municipal Bond Index||1.9%||2.1%||10.7%||10.7%|
As we reflect on the challenges of this past year and the investment climate today there are a variety of themes that
continue to impact our investment decisions:
- European debt problems continue to cast a net of uncertainty on the rest of the world. We continue to see start – then stop efforts to address the sovereign debt problems of the European Union countries. This is a very complex issue with no easy answers, but we do have some optimism that improved solutions will emerge in 2012. A recapitalization of some European banks seems warranted to help stabilize the crisis. A December 2011 move by the European Central Bank to offer 3-year low cost loans to Europe’s banks, secured by an expanded set of acceptable collateral, offers some promise to better position those banks for future purchase of sovereign debt issues.
- The U.S. economy has been improving despite all the pessimism. Since hitting a soft patch this past summer, our economy continues to slowly expand, supported by consumer spending and corporate strength. Our research leads us to conclude that the U.S. economy will most-likely continue to muddle along with slow growth. We may also see shorter economic cycles and more frequent recessions in the future.
- Politics continue to play a central role. As a result of budget deficits, government debt levels and failures of U.S. and European leaders, politics have taken hold of the financial markets in a manner not seen for decades. We expect political uncertainty to continue to affect the markets at least until the election in November and some consensus from European leaders.
- Equity valuations remain attractive. When we look at the “trailing” Price to Earnings ratio (P/E) of all U.S. Corporations, the stock market is trading at a valuation level below the average seen during recessions (12.6x average P/E during recessions versus 11.5x P/E at December 31, 2011 – lower P/E ratios indicate stocks are cheaper). During expansionary economic periods the market has traded at a level closer to 14x trailing earnings. Because the economy is expanding (albeit slowly) we believe today’s low valuation of the stock market offers a compelling opportunity for long-term investors.
- US Treasury interest rates continue to hover around historical lows. To protect against an eventual market-driven increase in interest rates we have positioned the majority of our fixed income allocation into shorter-term bonds. This reduced return over the past year, but we believe it will provide protection against rising rates in the future.
- Emerging Markets offer compelling growth opportunities. GDP growth rates in the emerging economies of the world are projected to be more than double the GDP growth rates in the U.S. and Europe. Emerging economies include countries like China, India, Russia, Mexico, Korea, South Africa, and Brazil. Because of this we now invest the majority of our international stock allocation in emerging countries.