The S&P 500 was down about 1% in the fourth quarter. Uncertainty in the run up to the Presidential election in November and political impasse over the deficit did not prevent stocks from hanging on to a double digit gain for the year. The fiscal cliff was averted at least temporarily. The debt ceiling / sequestration conflict to come could mean volatility comes back.
Corporate earnings continue around all-time highs. Companies in the S&P 500 are expected to grow by about 5% in 2012. Earnings are expected to remain in slow growth mode in 2013 as well. The current forward 12-month price to earnings (P/E) ratio for the index is about 13 (at 1,472 on the S&P 500 and forward 12-month EPS estimate of $113). The average forward 12-month P/E ratio is about 14 over the past 10 years.
Gross domestic product growth was 3.1% in the third quarter of 2012 (data released 12/20/2012). Projections for 2013 call for low growth around 2%.
The Index of Leading Economic Indicators decreased slightly in November confirming a flat trend for the last six months. Gains in residential construction and financial components (including stock prices) are offset by weaker consumer expectations. The reading indicates little or no growth expectation for the first part of 2013.
Commodities faded to close the year in negative territory. Crude oil decreased 7.1% in 2012. Gold was down about 5% in the fourth quarter to finish the year up about 7%. Agricultural commodities had a volatile year but did advance for the most part in 2012 (corn 8%, soybeans 18%, and wheat up 19%).
The housing sector is in the midst of a recovery with prices rising about 4% in 2012. Higher demand, lower inventory, and fewer foreclosed properties (sold at a discount) are contributing to the improvement.
The unemployment rate is 7.8% according to the December jobs report. In 2012 employment increased at an average of 153,000 per month following a similar increase in employment in 2011.
The Federal Reserve is signaling near zero interest rates indefinitely. There was some targeting added to the language to indicate easing as long as inflation stays below 2.5% and unemployment remains above 6.5%.
Inflation remains consistently low. November’s core consumer price index (released 12/14/12) shows annual inflation of 1.9%. Employment and deficits may play a prominent role in the future.
The yield on the 10-year Treasury note finished the quarter at 1.76%. Investors see US government bonds as the world's safest investment and believe that the country's long-term financial issues will be resolved. The low yields could be a temporary safe place to ride out market turmoil. Low yields could also reflect a deteriorating outlook for the economy. Long-term yields fall when investors expect slower growth or a recession ahead. Another factor that can move yields is inflation expectations—stronger economic growth often equals higher inflation, meaning investors will demand a higher return on investment. A low Treasury yield means that investors foresee little inflation. Finally, cheap borrowing enables and may even encourage the government to borrow since the interest on debt is low.
Stocks were generally up outside of the US in the fourth quarter. Europe still faces numerous headwinds but China’s growth has reaccelerated and Japan’s new government is attempting to stimulate their economy.
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