Special Update: 2012 in Review

With 2012 behinds us, it’s time to take a look at the events that shaped the year and consider what lies ahead. 2012 was a year defined by tremendous hope as well as ongoing fears about the future. Despite a painfully slow recovery, GDP growth looks like it may end up exactly where economists said it would: between 2.2 and 2.7% for the year.[i] Markets also made major strides, helped along by a last-minute rally as a fiscal cliff compromise approached. Let’s take a look at some of the major highlights of 2012:

The Fiscal Cliff

Going into 2013, the story on everyone’s mind was the fiscal cliff. Fiscal cliff debates provided budget watchers with a real nail biter as Senate discussions continued early into the morning on January 1. While the Senate and White House were able to hammer out a last-minute 2 AM compromise, the deal met resistance in the House on Tuesday, and discussions went late into the evening. The House eventually voted to approve the plan, but negotiations are by no means over. Congress must approve an increase in the $16.4 trillion debt ceiling in mid-February before current federal funding runs out, and another government shutdown threat looms.[ii] Whatever happens, we are committed to keeping you informed about this issue.

According to Congressional sources, here are a few of the major provisions of the deal:

–       Postpones for two months the start of $1.2 trillion in automatic spending cuts known as sequestration.

–       Raises $600 billion in revenue over 10 years through tax increases on wealthy Americans.

–       Permanently extends the Bush Tax Cuts for income below $400,000 per individual, or $450,000 per family. Income above that level would be taxed at the highest rate of 39.6%. For earners in the top bracket, capital gains and dividend tax rates would return to 20%  from 15%.

–       Permanently patches the AMT.

–       Extends unemployment benefits for one year for the long-term unemployed.[iii]

So although technically, we went over the fiscal cliff, it makes no difference to the economy whether the compromise was reached on December 31, or January 2, since legislation can be backdated to January 1.[iv]

Markets

Turbulence largely defined markets in 2012. Investors were battered this year by elections, concerns about a global slowdown, and fears around the fiscal cliff. However, despite some serious headwinds, equities put up respectable results, with the S&P gaining 13.41%, the Dow gaining 7.26%, and the Nasdaq gaining just under 16%.[v] Between June 4 and October 5, the Dow increased 12.31% during a summer market surge that surprised analysts who dubbed it a ‘sugar high,’ not supported by fundamentals, but by expectations of additional quantitative easing by the Federal Reserve.[vi]

The gains in U.S. equities this year were lead by homebuilders and financials, who outperformed markets as a whole. Housing remained a bright spot in the broader economy as housing starts, new home sales, and tight housing supplies contributed to sector gains. Financial stocks were able to produce significant returns despite debt worries largely because of gains in the housing sector. [vii]

The 2012 Presidential race roiled markets as candidates outlined their plans to boost the economy. The Eurozone crisis provided another headwind for markets concerned that Europe’s slowdown would affect U.S. companies. Despite Europe’s struggles, Euro region equities returned more than 15% in 2012.[viii]

The Economy

To say that the economic recovery stalled in 2012 is somewhat accurate but doesn’t tell the whole story. While the economy sprinted out of the gate during the first quarter, the momentum faded in the Spring, leading many to worry that we were seeing 2011 all over again. However, as Summer led to Fall, we saw that the economy was indeed growing, but at a slow pace. Surprising many, the economy picked up during the third quarter, posting growth of 3.1%. A bright spot in an otherwise drowsy recovery has been manufacturing, which managed to hold its own between January and October, spurred by lower energy prices.[ix]

Earnings were generally disappointing in 2012 as U.S. businesses struggled with challenging market conditions. On the positive side, while revenue was down, profits were up, indicating that companies got better at doing more with less and are poised to grow once demand increases.[x]

Unemployment started looking much better in 2012, dropping from 8.5% in January to 7.7% in November. As always, the larger unemployment number obscures a lot of detail, in that some of this decline can be attributed to discouraged jobseekers dropping their job search. However, overall, the trend is in the right direction, leaving us hopeful for 2013.[xi]

Although it’s too soon to know what final fourth quarter numbers will be, retail sales, a major driver of annual revenue for many companies, look soft. Holiday sales got off to a great start in November, but appear to have closed with a whimper. According to analytics firm Retail Metrics, December same-store sales may have grown just 1.9% over last year, well below their 2.5% estimates.[xii] These results may push down fourth quarter earnings for retailers.

The Federal Reserve

An activist Fed proved to prop up markets in 2012 by announcing multiple waves of ‘quantitative easing.’ These bond-buying programs were designed to lower interest rates and encourage lending by purchasing first Treasury bills and then mortgage-backed bonds. However, we’re not certain that Bernanke’s mojo will hold through 2013. Taking a look at past QE operations, the first QE program saw the S&P gain nearly 70%, while QE III in September 2012 has presided over a net S&P loss of nearly 4% as fiscal cliff concerns weighed on investors. The most controversial move took place on December 12, when the Fed announced QE IV, in which it promises to buy bonds until unemployment is less than 6.5%.[xiii]

In Summary

Whatever challenges we face in the year ahead, rest assured that opportunities will exist for those who look in the right places. As a firm, we will continue mining for those opportunities and will work hard to match our clients with investments designed to reach their financial goals. And, as always, we will continue to educate you and keep you informed about anything with the potential to impact your financial future. We consider it a great privilege to support you in this capacity, and we will continue fighting to protect the lifestyle you’ve worked so hard to earn – in 2013, and beyond!

ECONOMIC CALENDAR:

Tuesday: U.S. Markets Closed for New Year Holiday

Wednesday: Motor Vehicle Sales, PMI Manufacturing Index, ISM Mfg. Index, Construction Spending, FOMC Minutes

Thursday: ADP Employment Report, Jobless Claims, EIA Petroleum Status Report

Friday: Employment Situation, Factory Orders, ISM Non-Mfg. Index

Notes: All index returns exclude reinvested dividends, and the 5-year and 10-year returns are annualized.
Sources: Yahoo! Finance, MSCI Barra. Past performance is no guarantee of future results.
Indices are unmanaged and cannot be invested into directly. N/A means not available.