Throughout 2012, investors were subject to a continuing stream of bad news. But investors who acted upon their fears by exiting the equity markets missed out on strong returns.

 

The year opened amid concern about the weak US recovery, the debt crisis in Europe, fears of a slowdown in China, and political uncertainty around the world.  Some predicted a eurozone breakup triggered by impending debt defaults in Greece and Portugal. The global economy was weak, and many investors were weighing the potential economic impact of the US elections and so-called "fiscal cliff."

 

The world stock market performance chart below offers a snapshot of global stock market performance, as measured by the MSCI All Country World Index. The global headlines show that despite an abundance of negative news during the year, global stocks had an exceptional year. 

 

 

 

 

Economic Backdrop

 

Sluggish US Recovery

The current expansion, which started in mid-2009, is the weakest in postwar history. The norm is for deep recessions to be followed by strong recoveries. Overall, there was continued weakness in job growth, real wages, consumer confidence, and spending. Of course the news wasn't all bad. Healthy corporate earnings, low inflation, falling oil prices, low mortgage rates, and a strengthening of the housing market were among the more positive economic indicators.

 

Continued European Debt Troubles

The eurozone continued its sovereign debt problems particularly Greece, Spain, and Italy. The European recession prompted banks that are holding the troubled assets to reduce lending, which contributed to lower growth across the region. During 2012, the euro finance ministers agreed on a second bailout package for Greece. In May, concern grew over Spain's fiscal health when a major bank requested a massive bailout and disclosed troubled assets. Following the Greek election in June, the European central bank pledged to provide monetary support to protect the euro, leading to a rally in stocks and bonds.

 

Rising Global Economic Worries

During the first half of 2012, China's economy showed signs of weakening, with growth expected to fall to around 8% - a significant drop from its historical growth rate. China exports heavily to the eurozone. In the latter part of 2012, concerns over slowing growth in emerging markets had begun to ease as economies appeared to bottom out. Europe faced its own worries as austerity programs threw several economies back into recession.

 

Stabilizing Actions by Central Banks

Many investors did not appear to anticipate the degree to which markets would positively respond to central bank actions. Many analysts credit the US and European central banks with boosting investor confidence in both markets, and in the case of the European Union, helping avert a euro breakup. In September and October, the Bank of Japan announced measures to provide monetary stimulus through 2013 in response to slowing economic activity.

 

 

2012 Investment Overview

 

Highlights

After a flat 2011, the US stock market posted a strong first quarter as the US economy showed signs of improvement and perceptions of the European debt crisis improved. The start of the year was the best first quarter for US equities since 1998. When the second quarter began, markets retreated as Europe's debt crisis returned to center stage and signs of slowing global growth emerged.

 

By June, US stocks had surrendered all of the year's gains amid continuing concerns about the eurozone's sovereign debt problems. The US economy showed more signs of weakness. Stock markets around the globe stumbled in the second quarter, with non-US stocks suffering the most. During the summer, the markets improved, as European tensions eased on increased European Central Bank loans to Spain and Italy. There was also rising speculation that the Federal Reserve was prepared to deliver additional monetary stimulus to the US economy.

 

In September, the Fed announced its third round of quantitative easing to push long-term interest rates lower. The Bank of Japan also announced a stimulus plan. These central bank actions helped drive the markets during the third quarter. The S&P 500 surged 14% from its June 1 low and reached a five-year high on September 14. US economic indicators sent mixed signals, the economy reportedly expanded at a 3.1% rate for the 3rd quarter - the fastest pace since late 2011 -  but apparently shrunk by 0.1% in the 4th quarter. Mortgage rates reached historical lows, and year-over-year home prices rose for the first time since the 2007 financial crisis.

 

In the fourth quarter, investor attention turned to the close US election and the prospect of gaining certainty regarding future government spending, taxes, growth policy, and regulation. Stocks fell in the weeks following the election as investors gauged the prospects of continued political gridlock and the economic impact of spending cuts and tax hikes, known as the "fiscal cliff." The S&P recovered its earlier losses in the quarter by late December.

 

Market Summary

All major US market indices were up substantially for 2012. The S&P 500 gained 16% including dividends. Non-US developed market indices performed even better. The MSCI World ex USA Index, a benchmark for large cap stocks in developed markets outside the US, returned 16.4%. The MSCI Emerging Markets Index returned 18.2%.

 

Small cap and large cap stocks had similar performance in the US, but small cap substantially outperformed large cap in both the non-US developed and emerging markets. Value stocks outperformed growth stocks in the US and non-US developed markets, while slightly underperforming growth in emerging markets.