What a year it was. Consider all that the markets dealt with in 2011 and are still dealing with: Trouble in the Middle East, domestic political issues especially on the state level, Europe and domestic fiscal issues, and on and on and on. On the whole, however, the year didn’t turn out as bad as it could have given all of the above, but it also didn’t turn out as hoped for. While the 2011 results are presented here, watch for our 2012 forecast soon.
Expecting slower growth than what the Federal Reserve was forecasting, we felt that GDP would grow around 3.0% for the year but due to a slower start to the year we revised that number even lower. Listed below are our original expectations for 2011, any relevant updates to that forecast (original and adjusted forecasts are italicized) and the results as we have them:
- GDP will grow around 3.0% for the year; revised downward to 2.25% to 2.75%. At this point, the year end number is expected to be around 1.8%. We were closer to the mark than many others.
- Policy makers will continue to deal with the current economic situation for the first half of the year and then, if the economy is continuing to grow, will begin to focus on long-term fiscal issues in the second half of the year – The process of dealing with fiscal issues actually began sooner than expected. While there has been some work in this area, perhaps the biggest effect has been a dramatic decline in the confidence that Americans have in their lawmaker’s ability to make significant and appropriate changes that will revive and sustain the economy.
- The economy may face some headwinds should policy makers focus too much, too soon on long-term fiscal issues – Because so little has been accomplished, there is a high level of uncertainty as to what can be done. The markets have been very volatile this year partly due to the lack of direction from Washington.
- Unemployment will likely drift lower to 9.25% to 9.5% – The unemployment rate has declined further and faster than anyone predicted and it now stands at 8.5%. Unfortunately, part of the reduction is due to those who have given up looking for a job and are now not officially counted as unemployed.
- Interest rates will hold relatively steady due to little or no Fed action – In fact, the thought process now is that rates may not rise until 2013 at the earliest.
- Core inflation will increase slightly, to around 1.5% while food and energy prices will see more significant changes – Food and energy prices did see significant swings in 2011 although they declined slightly at the end of the year. Core inflation outpaced expectations and currently stands at 2.2% which is the highest level since October, 2008.
- The U.S. dollar will decline slightly against foreign currencies but the threat of a currency war will help soften the decline – The general direction has been downward although there were times when a rush to safety has caused the dollar to rally. The decline in the dollar helped increase exports – which was one of 2011’s bright spots.
- Consumer and business spending will pick up slightly – Generally, this has been true although it is also industry specific. Consumer spending outpaced expectations over the holiday season bringing both hope and concern for 2012.
Heading into 2011, we were somewhat optimistic, suggesting that the S&P 500 could show a 9% plus gain on its way to a level of 1,373. Even with the turmoil in the markets, the S&P 500 was at 1,320.64 at the end of June. However, trouble was brewing and ultimately the Index finished a hair below breakeven. Our forecast for 2011 and the results:
- Most financial planners and investment managers bullish on stocks – optimism faded and an extreme level of volatility took over making it increasingly hard to hold onto a bullish outlook.
- S&P 500 end of year target of 1373 which is approximately a 9.2% gain – we finished at 1257 basically breaking even although showing a very slight loss for the year.
- Corporate earnings will grow by approximately 10% – Forecasted earnings are likely to be on the low side as expectations for full year 2011 should be around 15%.
- Earnings comparisons will be difficult – As noted above, earnings came in better than expected.
- Large, multinational corporations will lead the way – This held true as investors sought safety in financially strong, multinational companies. The fact that the Dow Jones Industrial Average led domestic indexes is strong evidence of this.
- Tech, energy, and industrials will be leading industries – Results are a mixed bag here. While these sectors did reasonably well, they were overshadowed by health care, consumer staples, and utilities all areas expected to do well in an uncertain economy.
- Commodity prices, including oil, will increase – Another mixed bag as certain commodities soared only to fall flat including gold and copper. Oil has been up and down but has generally stayed in the $90 to $100 a barrel level.
- Dividend paying stocks will outperform – As noted above, financially fit corporations, especially those paying a reasonable dividend, did well in 2011.
FIXED INCOME MARKETS
Like many others, we were wary of the fixed income markets as we entered 2011. With a growing economy we expected the perception of rising rates to impact the markets in a negative way. Some felt a bond bubble was building and if it burst would cause significant harm to fixed income investors. Muni’s were under the gun as state and local governments struggled to meet budget demands. The only way to garner income was through higher yielding securities. The year turned out better than expected. Our expectations for 2011 and related notes including year-end results:
- Interest rates not likely to move dramatically higher – We hit the mark here.
- Upward ticks in inflation and interest rates will occur later than earlier- While rates did tick up early in the year, they settled back down. Inflation began to tick higher but wasn’t a significant issue due to slowly growing economy.
- Fixed income return expectations should be lowered and returns will primarily be determined by yield – Generally this held true.
- Slowly growing economy should prevent a bond bubble bursting scenario – This held true.
- Corporate bonds preferred over treasuries – This was a mixed bag as treasuries rallied due to safe haven status. Corporate bonds had a nice run due to strong balance sheets. Treasuries returned 9.81% and corporate bonds returned 8.15% as measured by aggregate indexes.
- High yield securities will be main source of additional yield – for greater yield this was certainly true but high yields also were under pressure at times due to risk concerns.
- Opportunities will be available in muni markets but budget problems do pose some risk – This held true and will continue to be true as we enter 2012.
- Extending duration may be more valuable than taking on more risk – This certainly held true as rates didn’t move and concerns over risk were the primary concern.
- Use of alternative tools such as TIP’s and floating rate securities provide some protection – held true to some degree. Floating rate securities finished the year slightly positive while TIP’s had a solid year. Fixed income as a whole provided some protection against the volatility experienced in the equity markets.
While forecasting is just that – a forecast or prediction of things to come, we did reasonably well. The stock markets did not do as well as expected or as well as they should have given the strength in earnings. Fundamentals took a backseat to volatility and left investors struggling to make sense of things. The fixed income markets were, if anything, more stable than expected and provided some relief. Concerns over fiscal issues in Washington and (especially) in Europe caused almost daily swings in the markets that pushed many investors to the sidelines. Those that stayed in the game took refuge in financially strong large cap companies that paid dividends and/or were in defensive industries such as health care, consumer staples, and utilities.
Watch for our 2012 Forecast soon.