As indicated in our last report, the 3rd quarter had its worst performance since the first quarter of 2009.The 4th quarter of 2011 saw this all reversed, primarily in October, as investors flocked back into equities.The main beneficiary of this rebound was the stock funds that had been hit the hardest in the previous quarter.These were primarily small and mid-cap funds that generally do poorly in slowing economic cycles.
Overall, the market was up by about 11% during the quarter.Markets overlooked the European crisis for the time being and focused more on the better economic news that was coming from U.S. companies.The fourth quarter proved to be the strongest of the year.
2011 in review:
Coming into the New Year in 2011, forecasts were for an excellent year for equities.The domestic economic recovery appeared to be in full swing and corporate profits were on track to hit record levels.In addition, a huge $2 trillion in cash was sitting on corporate balance sheets to be used for expansion, job growth, and acquisitions.In fact the first four months of the year were good as the market hit three-year highs in April.This was despite high oil prices after the outbreak of revolution in the Middle East which was quickly followed by Japanís earthquake/tsunami.
But the debt crisis in major Western economies proved to be the marketís undoing.Investors became fixated on Europeís debt crisis and congressional infighting over the U.S. debt ceiling.Stocks jumped and plunged as European leaders struggled at numerous summits to head off the crisis.That fueled investor concerns about a Greek default and even the possibility of a euro-zone breakup.
In August the troubles were ready to boil over.After a congressional fight over the U.S. deficit, S&P downgraded the U.S. credit rating, helping to set off the wildest swings of the year.In early August, the Dow moved 400 points or more for four straight days.At the end of August the S&P Index was down over 6%.As we moved through the third quarter, China added to market fears as investors worried about that central governmentís ability to rein in inflation, particularly runaway property prices.The countryís manufacturing engine also showed signs of slowing as the euro zone, Chinaís biggest trading partner, appeared to be heading toward recession.As a result of these concerns the S&P 500 dropped another 6% in September.For the quarter, the S&P was down 14.3%.
Just as quickly as the market dropped in the third quarter it rebounded by 11% in October as corporate earnings proved to be better than expected and Europe made some progress in the sovereign debt situation.November and December were basically flat so the S&P finished slightly positive for the year, up 2.1%.
While pessimism remains widespread, many analysts expect the market to return strong gains in 2012.Economic indicators picked up in late 2011.Expectations are for a continuing of these improvements as we move into 2012.Companies are keeping inventories low and not doing a lot of hiring (as seen by the high unemployment rate of 8.6%).They are managing costs very well so any increase in revenues will flow right to the bottom line as earnings increases.Earnings for S&P 500 companies should increase about 10% this year.In addition the price/earnings multiple currently at12.5 times is low compared to the 20 times multiple of the last several decades.
Of course, much depends on the European situation.Investors were whipsawed by the European debt crisis this past year.Europe should not surprise investors as much this coming year, no matter what happens.Another risk is Washington.We still have to deal with payroll tax-cut extensions, the debt ceiling and a resolution longer term of the deficit reduction problem.In addition, Washington could have something to say about the performance of healthcare, among the star performers in 2011, as the Supreme Court takes up President Obamaís health-care bill.Finally there is the election next November.The rhetoric will get much worse in an election year and this could hurt confidence as we move toward the end of 2012.
Allocation is crucial:
Allocation of funds in portfolios remains a key to performance. Our allocation continues to hold up well in down markets and is more stable than the overall market. GNMA bond funds gained 7% during the year, and the Vanguard Healthcare fund gained over 11%.Small-cap stocks, normally the riskiest of investments had the worst performance during the year with mid-caps following and large caps performing the best of the group.Markets rebounded in the fourth quarter led by small-caps and mid-caps.These smaller capitalization funds should do well in 2012.We also ensure that clients have diversification across industry lines as well as between growth and value funds.With prudent allocation, portfolios are poised to withstand shocks as well as reap the rewards.
Bruce A. Kraig, MBA, CFP January 6, 2012
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