The stock market moved sideways in the fourth quarter, but remained up strongly for the year.
Politics seemed to dominate the news in the last quarter of the year as the noise of November’s presidential election quickly turned into worries over the impact of the fiscal cliff. There was less activity outside of the U.S. as Europe remained mostly calm and emerging markets saw steady grown. Even though there was a fair amount of volatility, the markets barely moved, the S&P 500 was down about -0.4% for the quarter.
4th Quarter Results:
Talk of the fiscal cliff exploded after the election, as the market anxiously awaited to see if leaders in Washington would be able to avert the scheduled tax increases and spending cuts expected to begin January 1. Hopes for a deal increased on signs that Republicans were willing to accept higher revenues and the Democrats were willing to put entitlement reforms on the table. A quick resolution to the fiscal cliff problem was not possible as divisions over how to raise revenues and magnitudes of cuts proved hard to close.
The impact of the cliff could be felt throughout the quarter. The uncertain tax environment caused companies to make changes even ahead of the New Year. A bunch of corporations issued special dividends, sped up the payment of regular dividends and slowed down some investments.
The Federal Reserve also provided a bit of a surprise during the quarter by, for the first time, tying its monetary policy to a specific economic indicator rather than to a time period. The central bank said that it would continue its easy monetary policy until the unemployment rate hit 6.5% from the current rate of 7.7%. The commitment is not binding as the Fed said that it would act if inflation began to become a problem or if the rate fell because of a reduction in the workforce. Still, the statement was another sign that the Fed plans on keeping rates incredibly low for years to come.
As we now know, the fiscal cliff crisis has been averted with an increase in taxes on individuals making more than $400,000 a year and couples earning more than $450,000. The problem of expense reduction was basically left alone, however. Nevertheless, equity markets responded positively to this resolution by rising 2.5% on the first business day of the new year.
As we enter 2013, one of the major concerns has been removed, resolution of the fiscal cliff. With this out of the way, investors can once again return to focusing on fundamentals. Corporate America is doing quite well with expectations for about a 9.5% gain in earnings for the coming year. Corporations have also been hoarding cash. The amount of cash and cash equivalents climbed to an all-time high $1 trillion at the end of September. This is 65% of the total the companies had five years earlier. With more certainty, some of this cash can be used to hire and expand businesses which have been missing during the economic recovery of the past 3 years.
Investors should also be more willing to own stocks as we move into 2013. During the past three years, investors globally have poured nearly $700 billion into bond funds while pulling nearly $300 billion out of stock funds. This will probably end in the coming year. Bonds have become so expensive that it is unlikely that prices can go up much more (prices go up as interest rates decline) as interest rates have gone down so much over the past three years.
Stocks in the S&P 500 index are currently trading on a price-to-earnings ratio of about 13.5, compared to an average of 17.9 times since 1988. The ratio rises when investors are willing to pay more for a stock’s future earnings potential. If earnings go up the estimated 9.5%, and if the P/E multiple remains the same, stocks can be expected to rise this 9.5% plus a dividend yield of about 2% or in the 10-11% range. This would be an excellent return.
Allocation is the key to a portfolio that holds up well in down markets and is more stable than the overall market. Last year, large-cap companies did well, particularly those in the growth area. Growth funds did better than value funds in 2012. While many analysts expect growth funds to continue to exceed value funds, diversification is a crucial component of allocation. We structure each client's portfolio individually, customized for their goals, time horizons, and comfort level. If your allocations are not performing well, give us a call.
Have a nice winter.
Bruce A. Kraig, MBA, CFP
January 5, 2013
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