Year End Update
For the investor looking for a calm, headline free year, they certainly didn’t find it in 2012. From the potential impact of the Fiscal Cliff, to continued concerns of a spread of the European crisis, the possibility of an Israel and Iran conflict and weakness in emerging market economies, there were plenty of reasons and news stories to make any investor want to pullback to conservative assets. For the investor who stayed in the market, they were rewarded with markets ending up strong for the year with the S&P 500 up 13.47 percent, the Dow Jones up 7.16 percent and the Nasdaq 100 up 16.66 percent.
The strong performance for 2012 was not without its ups and downs during the year. In the 2nd quarter the S&P 500 declined almost 10 percent from its April highs with the main culprits being worries over the US and Chinese economic growth, along with concerns with Europe. The S&P hit its high for the year in September followed by a drop in the market in November caused by concerns over the election results.
Strong market performance was also seen in the international markets for 2012 with the MSCI EAFE index, which tracks the equity market performance of developed markets outside of the U.S. & Canada, up 14.80 percent and the emerging market index up 16.9 percent. As is often the case, the performance of emerging markets varied widely with countries such as Mexico up more than 31 percent while Brazil was down more than 2 percent.
The performance of the bond market index was positive, but it was much more tepid than previous years with the Barclays Aggregate Bond Index up 1.15%. In July of this year the rate on the 10 year Treasury bond hit a historic low of 1.40 percent. The Fed Reserve indicated they would keep rates low since the unemployment rate, which declined to 7.8 percent in December, is still above historic averages and inflation at 2 percent, is below historical averages.
Commodities and Gold were up modestly for the year with returns of 3.5 percent and 6.6 percent respectively.
From an economic perspective, things continued to improve at a very modest pace in 2012. There was strength shown in the residential real estate market, automobile sales and retail sales during the year. The manufacturing sector and capital investment by businesses showed weakness in the second half of the year due in part to businesses having concerns over the Fiscal Cliff. The US GDP growth is expected to come in around 2 percent for the year and global economic growth is forecasted to be 3 percent for the year which is down from previous years.
Overview of Fiscal Cliff Legislation
One of the biggest issues for 2012 was the Fiscal Cliff and the potential for large federal tax increases and spending cuts to be implemented in 2013. Congress delayed coming to an agreement until after the New Year deadline and the final deal postponed any discussion of sequester spending cuts until February. This discussion on spending cuts, combined with the need to increase the federal debt ceiling at the same time may cause increased market volatility in February. At this point, we are not adjusting our portfolio asset allocations as we feel this is a short term issue and as long as it is resolved in a reasonable timeframe it will not impact long-term economic growth.
As for the recent agreement, it is a lengthy piece of legislation that includes many items. Below we have highlighted a few important items from the law.
- Raises $620 billion in revenue over 10 years through a series of tax increases on wealthier Americans.
- Permanently extends tax cuts enacted in 2001 under former Republican President George W. Bush for income below $400,000 per individual, or $450,000 per family. Income above that level would be taxed at 39.6 percent, up from the current top rate of 35 percent.
- Above that income threshold, capital gains and dividends tax rates would return to 20 percent, from 15 percent.
- Caps personal exemptions and itemized deductions for income above $250,000, or $300,000 per household.
- Raises estate tax rate to 40 percent for estates of more than $10 million per couple, up from the current level of 35 percent.
- Includes a permanent fix for the alternative minimum tax.
- Extends unemployment insurance benefits for one year for 2 million people.
- Extends child tax credit, earned income tax credit, and tuition tax credit for five years.
- Avoids a cut in payments to doctors treating patients on Medicare – the “doc fix.”
- The payroll tax holiday was not continued which raises the tax rate from 4.2% to 6.2%.
Outlook for 2013
Overall, as we look forward to 2013 we are cautiously optimistic about the markets and the global economic environment. In the US, beyond our immediate concern of how the debt ceiling will be handled, we should see continued strengthening in the housing market which has not been a strong point in the economy over the past 6 years. The energy industry in the US will also drive economic growth with increased production of natural gas and oil resources. Finally, if business and consumer confidence can build as the economy strengthens, this will become a positive cycle that will build on itself.
From an international perspective, many of the emerging markets are showing signs of continued strength and at the some point this year, Europe could begin to turn the corner and see some positive growth or at least see things bottoming.
As for risks, there are still significant areas of concerns in the world, many of which are carryovers from last year. As we evaluate these risks, we do not put a high likelihood of any of them worsening to a point where they could greatly impact the global economy. The one additional risk this year is any drag that could occur to the economy from increased taxes and decreased spending by the federal government. Even with the recently approved tax increases, there will be some drag, the question is how great the drag will become if the taxes are further increased and current federal spending is cut dramatically in upcoming negotiations.
A Positive Perspective
As we look forward to 2013, it is important for investors to look past the constant stream of negative headlines the media industry uses to sell its news product and to take the time to understand the real issues and data points that drive the long-term performance of the markets and the economy. The impact of all this gloom and doom reporting can be seen in a survey recently completed by the mutual fund company Franklin Templeton where they asked investors how they thought the market performed over each year from 2009 to 2011. Although the actual market performance was positive for each one of those years, the majority of survey participants thought the market was down during each of those years.
We wish you the best for 2013.
Steve, Marty & Ryan