by Liz Ann Sonders, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.
Key Points
- The Dow Jones Industrial Average (DJIA) managed a gain for the year in 2011, but very few investors were cheering.
- With inflation settling down, the upward boost to real gross domestic product (GDP) is likely being underestimated.
- Although the eurozone crisis may keep volatility elevated short-term, 2012 is looking like a better year.
"I always avoid prophesying beforehand because it is much better to prophesy after the event has already taken place."
—Winston Churchill
It's that time of year again, when we review the year that was and look ahead to the year that is. It's a time rife with forecasts, outlooks and predictions. At Schwab we do our part, but not quite like the others. At our company's core is the belief that disciplined investing is the key to long-term success, and that investing based on forecasts—yours, mine or anyone else's—is gambling in disguise. That is why we don't publish year-end price forecasts … I haven't a clue where the market will close the day I'm writing this and that's only a few hours away, let alone where it will close on December 31, 2012.
Expect the unexpected
What we do try to do is review trends, scenarios, possibilities and probabilities, while always keeping a close eye on the contrarian view. As Oscar Wilde said, "To expect the unexpected shows a thoroughly modern intellect."
Last year was a doozy. From the start of 2011 to the end of April, the S&P 500 Index rallied nearly 10%, only to plunge nearly into bear-market territory (-20%) by early October. It rallied back nearly that much by the end of October, giving back another 10% by Thanksgiving, but finishing with a nearly full recovery of that 10% over the holiday season.
The real trouble erupted in August thanks to a dysfunctional Congressional debate about the debt ceiling, a subsequent US credit-rating downgrade and the re-eruption of the eurozone debt crisis. The DJIA averaged a daily intraday swing of 270 points between August and November, more than double the spread over the same period in 2010.
A market full of "sound and fury, signifying nothing"
When all was said and done, the S&P 500 and the Dow did eke out gains for the year (though only thanks to dividends for the S&P). But that performance belied the turmoil of the year and few investors have been celebrating save for maybe those who stuck with US Treasury bonds over the year. Even the so-called smart-money hedge funds had a tough year: the average return was -5% according to Hedge Fund Research. There's little worse for a hedge fund than posting a negative sign before returns with the major indices in positive territory.
You can see the array of returns across many of the key global indices below:
2011 Asset Class Performance
Source: Bloomberg, Thomson Reuters, as of December 30, 2011.
Key to the year's initial surge into late April was the expectation that the economic recovery was picking up momentum. Those hopes, along with the market's rally, were dashed with a very weak second-quarter GDP report that was not only weaker than expected, but brought significant downward revisions to prior quarters' growth rates (including a whopping revision to 2011's first quarter from 1.9% to 0.4%). What we ultimately learned about the year's first several months was that a sharp increase in inflation took a big bite out of "real" (inflation-adjusted) GDP.
The $30 surge in oil prices in the five months through April 2011 likely carved about 1.5% out of GDP growth. There were also major weather disruptions to crop production that caused a spike in food inflation, and ushered in the Arab Spring. Add to that the March earthquake and tsunami in Japan, which wreaked havoc with the global supply chain, and we had the recipe for a brutal first half of 2011. The mistake some made was extrapolating this weakness into the future and assuming the weakness was secular, not cyclical and reversible.
Inflation takes over from Federal Reserve policy
Inflation has been, and will remain, a big driver on the margin of growth. In cycles past, Fed policy and its influence on short-term rates would move the needle on growth with nearly every tick. But with short rates pegged at zero since the end of 2008, this is no longer the case. What appears to now move the needle, given other growth constraints, is consumer inflation, which can make a big difference given limited income gains. Here's where there's some good news recently, and as we look ahead to 2012.
