Let us first recap what happened in 2011.
The S&P 500 was like a little kid hopped up on too much candy after Halloween. The index bounced up and down and ran all over the place but in the end this little kid never really strayed too far from home. 2011 was a rollercoaster of a ride, with loops, twists and turns but through all the volatility the S&P ended the year virtually flat (shy of a few decimal points). What caused this volatility?
The debt ceiling debate took center stage during the summer, and one rating company even downgraded the US. The downgrade though was caused more from the political circus rather than the actual ability to cover debt payments. Funny thing is, contrary to economics 101, this debt downgrade had no adverse impact on long-term Treasuries. As a matter of fact the yield actually fell further (much thanks to the world considering the US a safe haven) Other things we witnessed was more government intervention in the form of the Fed. The Fed tried what some may have called QE 2.5, or “operation twist”. In an attempt to keep rates artificially low the Fed buys and sells treasuries on behalf of the government. Last but certainly not least is the continuation of the always ever so near European debt crisis. European leaders are taking a slow but forward progress…for every two steps forward they take one step back.
The nations’ debt relative to GDP is high for each of the PIIGS (Portugal, Italy, Ireland, Greece, & Spain) but there are more factors influencing the debt crisis than just debt-to-GDP levels.
Greece’s main concern is that their GDP has yet to turn positive since 2009. Greece simply isn’t competitive, much of their lackluster economy has stemmed from decades of socialistic government policy. Roughly 40% of Greek workers are employed by government (which is a scary statistic when thinking the nation might default). To add to their troubles their private businesses are highly concentrated in only a few industries. They ranked extremely low on the World Bank’s “Ease of Doing Business” study, and the Fraser Institute’s “Economic Freedom of the World 2011” study. The only good thing to take from Greece is its size, it is not nearly big enough to do anything catastrophic.
Ireland’s economy (even smaller than Greece) is at least competitive. Their recovery is already taking shape by turning positive GDP numbers and their workforce employed by the government is half of that of Greece.
Portugal, also smaller than Greece, is showing signs of labor market reform and private-sector liberalization which is always good for business. Last year in an important election the Socialist party lost and a far more fiscally hawkish government took the reins.
Spain however, with its economy larger than the former three countries combined, can actually do some major damage. The signs are positive though as their debt to GDP level is only 60% (much lower than the others) and austerity measures have already been put in place as their deficit is starting to decrease.
Italy, another giant, is running a relatively small budget deficit and actually has a primary budget surplus (which excludes debt interest payments) Best of all most of its debt is held by domestic investors.
All in all the outlook in Europe is starting to look a little brighter, though still dim. As I said before, two steps forward, one step back. Contagion from Greek debt restructuring hopefully need not present a material problem any longer for banks as they’ve increased capital and liquidity while decreasing leverage.
As for 2012…
There are some positive signs, so long as the consumers’ emotions don’t continue to get in the way. First let us look at the fundamentals. Corporate earnings and revenue has continued to grow despite slumping stock prices, which in turn pushes valuation multiples to near multi-decade lows. What does this mean? Well, with interest rates near historic lows, it makes stocks competitive income-producing investments. Dividend yields are now higher than 10-year treasuries…meaning not only can you get paid higher income streams off blue chip stocks, but you can also have the opportunity for large capital gains. The only thing really hanging people up emotionally is the unemployment rate and housing numbers. First of all, unemployment rates are a lagging-indicator, which means it is often irrelevant to predicting future market performances. Secondly, we’ve seen progress as of late albeit it being slow progress. As for the housing numbers, typically sectors don’t exactly bounce back after bubbles burst. The housing market will take some time to recover, but the positive sign is that household balance sheets are improving. Debt to service ratios of US Households are lower now than it’s been over most of the last decade. On top of that banks are beginning to increase their lending again and have massive excess reserves.
Now let us look at the technical analysis. The 2012 US election can be beneficial. Historically the 3rd and 4th year of a president’s term is positive (on average 2% higher than the first 2 years). Either way the election goes, history has the numbers. Whenever a Democrat is re-elected markets rose 14.5% and when a Republican is initially elected into the White House the markets rose 18.8%. (Obviously historical performance is no perfect indication of the future, but that is the technical analysis). Another technical indicator is called the January Barometer – a higher January typically leads to a higher year.
I’ll be keeping my fingers crossed as January continues.-all statistics gathered by Fisher Investments Company
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