A New Year’s Resolution and Thoughts on the Markets

I haven’t quite solidified my personal goals for 2013, but one of them will be to write/blog more frequently.  I was thinking – though unreasonable it might be – that I’d set a goal to blog daily.  This might be a failed effort already considering it is now 1:20AM on the 2nd of January on the East Coast. Perhaps this specific goal will have a PST associated with it.

I wanted to share a few thoughts on the markets as we start the year.  With the markets closed New Year’s Day the focus has been on resolution of the Fiscal Cliff. The Committee for a Responsible Federal Budget covers the details the good, bad, and ugly here. I echo their sentiment that it is truly unfortunate we failed to use this opportunity to put into place measures necessary to stabilize the debt as a share of the economy.

I suspect we’ll see markets open higher on the first trading day of 2013 – not because of how Congress acted, but because they did act. 2012 is officially in the books and despite the volatility, when everything is said and done 2012 was a good year. Going back to 1926, the annualized total return (with dividends) for the S&P500 is 9.93 percent. In 2012, the S&P500 closed 13.41 percent higher than it opened (16% with dividends). 2011 was flat (up 2.11% with dividends). Midcap and SmallCap did even better with total returns of 17.88% and 16.33% respectively. Midcap and SmallCap have cumulative returns of 161% over 10 years – compared to 87% for the S&P500. Seems like it remains smart to have exposure to smaller companies and I expect that will remain true in 2013.

Vincent Farrell recently reminded me of the rule of 20 which states the “stock market multiple and the inflation rate historically, and consistently, total 20.” With inflation around 2% and as reported PE multiples around 14.7% for 2012 and 14.2% for 2013, it appears we have a lower risk stock market. At the same time financials were the biggest winners in 2012 – up 26% in the last year followed by consumer discretionary up nearly 22%. Pulte was the best performing stock in the S&P500 for 2012. Only utilities were down in 2012. Investors are becoming more risk seeking at the same time they are remaining skittish. I see asset allocations shifting at the same time investors are cautious as to what they are willing to spend for those earnings. The markets closed 2012 with the VIX lower than when they started 2012. Despite all of the events of 2012, we seem to be moving into a lower risk environment – for now. It is beginning to look like a real recovery (at least historically speaking) even if it doesn’t quite feel like one and it seems like a good time to be long the areas of the economy that will benefit most from a traditional recovery.

US. Companies appear ripe to make investments.  Large-cap S&P500 companies (old industrials) are sitting on a record $1T in cash and cash equivalents even after record dividend payments. More companies paid extra dividends in 2012 than in in the last 39 years. December extra dividend payments in 2012 was higher than we’ve seen in the last 57 years (1955)- suggesting companies were paying attention to what was happening in Washington. Expect to see more buybacks in the first half of 2013 and company acquisitions.

Interest rates were little moved in 2012. The 10-year U.S. Treasury closed at 1.75% compared to 2011 year-end close of 1.88% ( 2010 was 3.29% and 2009 was 3.84%). I expect this story to be true in 2013 as well. I like being long debt (ie being a borrower) – especially when I can lock those rates long into the future.

With all of this said, I expect 2013 could in many ways be more difficult than 2012 as reforms are implemented.  German Chancellor Merkel suggested this for Europe and I think the same applies to the US.