Our Expectations for 2012

19 01 2012

Jonathan N. Castle, CFP, ChFC

2011 has come and gone and we are rapidly working our way through 2012.  It seems that so far, a general sense of cautious optimism has taken over where only a few months ago, all we heard was gloom and doom.  We applaud what appears to be slightly more balanced reporting on the economic front.  While not all of the news is good, neither is it all bad as it seemed to be several months ago.  A sense of doom and gloom serves no good purpose for our economy, and we are pleased the mood appears to be lifting somewhat.

After reviewing a great deal of economic analysis and often conflicting opinions from our research providers, we have come to some general conclusions about what to expect for performance in the financial markets in 2012.  We have stated over the last several months that we are “cautiously optimistic,” or “moderately bullish.”  There is no substantive data that suggests we should change this outlook (details at the end of the article) – but that does not mean that we believe the road ahead to be easy, particularly for investors.  Nor does it mean that we are wearing rose-colored glasses, or our cups are always “half full.”  It simply means that we believe we will continue to improve – with occasional interruptions – from where we currently are NOW.  We also believe that it will take years for the economy to fully recover – but recover it will.

Our Major Concerns at this time are:

European Debt Crisis and Likely European Recession – Some experts believe that the European recession has already begun. Recent data points indicate that Germany’s economy contracted slightly last quarter, and it is likely that other economies will soon follow.  As we enjoy a globally integrated economy, European recession likely means slowing economic growth in the US and difficulty in achieving meaningful returns in international markets.

Rising Dollar – As the Euro weakens, other currencies, (including ours) strengthen against it.  A strengthening dollar makes it more difficult for US companies to export goods and may make it more attractive for US companies to outsource jobs overseas.  However, a strong dollar does have the benefit of making US debt more attractive to foreign investors looking for security.

Political Stagnation – The past 2 years have been a display of an embarrassingly dysfunctional government. Unfortunately, with 2012 being an election year, we believe it unlikely that any real policy change will occur until 2013 or beyond.

Overwhelming US Debt – this may be the most dangerous long-term economic issue we have to face. At some point, we must face the inevitable belt-tightening that will be necessary to keep the US afloat.  Either government spending must decrease, or taxes must increase – or both.  Neither option is good for the economy or financial markets.

The Fed is Out of Bullets – The Fed has reduced interest rates to the lowest that we have ever seen, and pumped trillions of dollars into our economy trying to stimulate economic growth.  However, the damage done to the economy during the Great Recession was so severe that most of the Fed’s actions served only to limit damage – not to create the opportunity for recovery that we were hoping for.  At this time, it appears that the Fed is nearly out of ammo and has few options left.  Fortunately, inflation has not been severe; if it were, the Fed would be forced to raise interest rates again, which would slow economic growth even more and investors holding bonds would see the market values of their bonds decrease.

US Consumer Belt-Tightening – A large part of our economy is based upon the American consumer.  While it is a bit embarrassing to say that our economy runs on us buying things we don’t really need – it is partly true.  As more Americans learn that they can, in fact, live without many of these luxuries, these dollars no longer stimulate the economy.  On a personal level, a reversion to thrift is positive and one that we wholeheartedly support.  On an economic level, however – especially as a service based economy, consumer thrift forebodes even slower growth than previously hoped for.

Rays of Hope and Sunshine

Receding Unemployment – ever so slowly, and certainly not in a straight line, unemployment figures are receding. This is a fact; there are jobs out there to be had.  Many are in small businesses where people are hired one at a time.  Some disbelievers say that unemployment is dropping “only because discouraged workers have given up looking for jobs.”  This argument is hogwash – new workers enter the job market on a daily basis, which offsets discouraged workers leaving or retiring early.  While the jobs may not be the premium top paying jobs that were available before – they ARE indicators of economic expansion from where we were two years ago.

Increased Home Sales – According to the most recent National Association of Realtors (NAR), housing sales appear to have stabilized.  Total housing inventory fell from an 11 month supply to a 7 month supply during 2011. Housing starts and permits are increasing, albeit slowly.  As the housing sector directly impacts over 17% of the entire US economy, this news – however tepid – is hopeful.

US Corporate Profits – US corporate profits are at a high not seen since before the tech-bubble crash.  While much of the profit results from cost-cutting, it is still meaningful. Increasing profits mean that most of the major US firms are on a solid fiscal footing, and are in a much better position to pay attractive dividends to shareholders and fund future expansions.  From a yield perspective – high quality stocks are now more attractive than bonds at current levels.

Improving Manufacturing Data – The December Manufacturing Institute for Supply Management (ISM) Report topped expectations with the factory sector barometer (known as the PMI) increasing to the best level in six months. The raw data of the PMI also indicates that the manufacturing sector has grown for 29 consecutive months, which is generally a good indicator of the future direction of the economy. ALL 3 major US automakers reported profits for 2011.

What to do?

“Buy Low, Sell High.”  We all know this.  Yet, many people are only comfortable investing when the economy is humming along smoothly and all the news is positive.  Unfortunately for these emotionally driven investors, periods of economic boom are often the most dangerous times to invest, because by then, markets are usually overvalued. (Buy High, Sell Low).  Remember – when everyone is already invested, there are no new investors to bid prices up further.  Being invested in portfolios designed to your personal risk tolerance – especially when markets are undervalued – has been proven to be a key to long term investor success.

Typical Bear Market Behavior

For the last 100 years, based upon a study done by Morgan Stanley in 2009 called “The Aftermath of Secular Bear Markets,” major bear markets typically behave as follows.  (Dates for our current bear market in parentheses).

  • Market Crash/Bear Market: -56% for 29 Months, on average (Oct 2007 – Mar 2009)
  • Rebound Rally: +70% for 17 Months, on average (Mar 2009 – Apr 2010)
  • Mid Cycle Correction: -25% for 13 Months on average (Apr 2010 – Aug 2011)
  • Trading Range: Sideways (but slightly UP) with 15-20% whipsaw behavior for 5.6 years, on average (Aug 2011 – ?)

Our current bear market appears to be slightly shortening the cycles, but, in light of current political dysfunction and the European Debt Crisis, we believe the “trading range” portion of the market cycle will likely last several years at a minimum.

For 2012, we believe the following:

  • Markets will continue to be choppy, sometimes uncomfortably so
  • We DO expect to see some growth out of stocks, but not particularly impressive growth
  • Larger, dividend paying stocks should play a large role in the equity portions of portfolios (as compared to mid- or small-cap stocks)
  • US markets will be less volatile, and return more, than developed international markets. Emerging Markets will suffer from the European recession.
  • Interest rates (and bond prices) will remain relatively stable
  • The US Dollar will strengthen compared to the Euro

Our suggestion is that investors focus on other issues over which they have control:

  • Maximize IRA, 401(k), Roth, and other retirement plan contributions.
  • Reduce debt wherever possible.
  • Cut back on unnecessary luxuries (cook at home more, examine utility bills, etc).
  • Examine opportunities for mortgage refinance or other strategies to lock in low interest rates.
  • Closely examine your tax strategies (Roth Conversions, capital gains realization, business sales, etc) to include the expectation that taxes will be higher in future years.

While this list is certainly not exhaustive, it is a good place to start.  If we can offer you assistance in making the decisions necessary to maximize your odds of success during these uncertain times, please don’t hesitate to give us a call.

This blog article is for informational purposes only and does not constitute legal, tax, or personal financial advice.  Please consult your own financial professional for personal, specific information.  PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP(R), CERTIFIED FINANCIAL PLANNER(tm) and federally registered CFP (with flame logo) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

Investment advisory services provided by Paragon Wealth Strategies, LLC., a registered investment advisor.  http://www.WealthGuards.com

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