• Supply chain disruption from the Japanese earthquake of March and follow-on nuclear plant problems
• US Congress bungles the debt ceiling legislation in July
• Standard & Poors downgrades US debt in August
• The permanent circus in Europe regarding Greek, Spanish, Irish, Portuguese and Italian debt and whether the Euro can be saved

But the bottom line is that, in the face of one amorphous gelatinous macro event after the other, the US stock market has managed to trade on either side of unchanged all year long.  Meanwhile, another quarter of record earnings are on tap starting the first week of January, inflation remains contained, interest rates remain low, and valuations are compressed.  Macro concerns are the lid, earnings are the flame - at what point does the pot bubble over?

40 year bull market in Financial Services ended in 2008
We believe that a bull market in financial services started in in the late 1970's with the end of the fixed commission system and accelerated in the 1980's as computers were brought to bear on financial applications.  However, it is the nature of financial innovation to go from proprietary product (think mortgage backeds, swaps, derivatives) to plain vanilla in a very short time frame.  The history of banking from 2000-2008 was of firms creating every more esoteric "products" which were leveraged for maximum profits.  No one will buy those products now and surely not on leverage, which means that banks are now stuck with expensive real estate and expensive staff, both of which are destined to shrink in coming years.
 

This table shows QTD, YTD and 5 year returns for the 10 major components of the S&P 500.  Financials, which at one point accounted for 22% of the market cap of the S&P single handedly account for all of the stock market's flat returns of the last 5 years.  Now financials account for 13.6% of the total market - large but not crushing.  It's also interesting to note that Consumer Staples and Utilities have done well in 2011 - those are the sectors that investor focus on when they fear recession. 

In fact, US economic growth has been gaining all year, not enough to reduce unemployment significantly, but the most recent report (2011 Q3) showed growth of 2.5% (3 or 3.5% would be considered good.)  Q4 is estimated at 2.7%, and current forecasts are for 1.9-2.5% through 2012.
 

Consumer confidence as reported remains at depression levels, though holiday retail sales may indicate optimism at least among those Americans that have jobs.  Elevated unemployment, still at 8.6%, remains the biggest drag on the economy.  120,000 jobs were created in the most recent report, but that barely keeps up with population growth.
 

Strategy
Three weeks remain in the year.  Stocks could finish up 5% on the year or down 5% on the year, most likely around +1-3%.  Given that the market undershot our forecast for this year, we think next year will offer above average returns of at least 12%.  We are fully invested in anticipation.