The fourth quarter 2012 was exciting: politically and economically. The re-election of Obama coincided with a strong stock market sell-off as the Market considered the political ramifications of a split Congress. The Market inched its way back up through December, but then was held back by fear of the fiscal cliff on New Year’s Day. The drama was high as the President, VP and house majority leader crafted a last minute tax deal that originated in the Senate and barely passed a divided house on January 1st.
If 4Q12 went out with a bang, 1Q13 has been just as thrilling. After a relatively flat fourth quarter (actually, it was slightly negative), the market exploded into the New Year. The year started with the Dow Jones 308 point rally on January 2nd, celebrating the last-minute agreement that kept us from falling off the "fiscal cliff" — at least for a while. From there, the Dow kept going until it established a new 5-year high close of 13,954 on January 29th, right on the cusp of 14,000!
In February, The Dow Jones closed at 14,054.49, up 1.4% for the month and continued into March where the Dow closed on March 5 at a new all-time high. Slightly more than four years after the crash low, the Dow surpassed the October '07 high of 14,165. The consistency of March’s climb was remarkable. The number of up days outnumbered the down days 3 to 1. In addition, there was not a single plus or minus day of 1% for the entire month. As a result, March ended with still another new all-time high, closing at 14,578.54, up 3.7% for the month.
Finally, to finish off the month in style, on the last trading day of the quarter, the S&P 500 finally eclipsed its October '07 high as well, closing at 1569.19. Both the Dow and the S&P 500 closed the first quarter up more than 10%.
Many economists believe that the good times will continue in 2013, calling for double digit gains again this year. It is easy to see how we can get there2. The Federal Reserve’s emphasis on a zero-bound interest rate policy ensures rates will remain low. Gridlock, if we truly have it, could also be a positive. Although government policy can often be a component of GDP growth, a true economic expansion requires a vibrant private sector expansion. We are seeing signs that sustained growth in the private sector may finally be taking hold.
Unemployment & Interest Rates:
While good news abounds in the Stock Market, the economy still suffers with recessionary levels of high unemployment and slow growth that necessitates that the Federal Reserve continues its low interest rate policy. This support will officially continue until GDP growth exceeds 2.5% and the unemployment rate dips below 6.5%. This may take a while to happen – the preliminary 4th quarter 2012 GDP indicated a slight contraction in economic activity and the January unemployment rate actually rose to 7.9%. Therefore, we continue to expect low inflation and interest rates for 2013 but caution that the economic forces allowing for this policy are beginning to disappear3.
Fiscal issues aside, one of the most important reasons we see grounds for guarded optimism is that progress has been made in repairing the excesses of the “bubble era”. Nowhere is this more evident than in housing4. Home prices have been brought into better alignment with fundamentals, while new building activity has run so low for so long that it has greatly reduced the housing hangover. As a result, housing is showing clear signs of improving, possibly foretelling a broader-based upturn in economic activity (the way housing's peak in 2006 foreshadowed the ensuing economic crisis). Meanwhile, households have improved their financial positions, trimming debt while benefitting from some recovery in asset prices and easing of credit conditions. At the same time, belt-tightening at state and local governments appears to be abating. Though the headwinds aren’t all gone, they arediminishing. And as they do, some of the avenues that normally provide activity (e.g., housing and refinancing) should open up. 5
On The Home Front: Energy Sector:
Another big stride has been the resurgent domestic energy sector. Improvements in drilling and hydraulic fracturing technologies have enabled the U.S. to rapidly increase the amount of oil and gas produced domestically. The surge has produced millions of direct and indirect jobs. Additional jobs have been created to manufacture the production equipment and pipeline infrastructure required to move the products to market and to produce the steel and other raw materials to make it all happen. New petrochemical plants are being built in Pennsylvania and elsewhere as companies seek to take advantage of the cheap feedstock being produced nearby. The U.S. now boasts some of the lowest energy prices in the industrial world, a competitive advantage that could be with us for many years to come.
Federal Budget Act
The U.S. Senate passed the first Federal budget in four years. Now the House of Representatives needs to vot on the Ryan package or some other version – and then the debate will begin6. The Senate has passed their budget – the highlight of which shows taxes rising by $1 trillion over the next 10 years, along with spending “cuts” of $850 billion over that same 10-year period. Much of the $850 billion is a reduction in planned spending increases, not an actual shrinkage in government spending. The planned cuts will affect most everyone in some manner, how it will affect the economy is yet to be seen. Stay tuned.
Beyond our borders, stabilizing trends can also be seen. In 2013, the worldwide economic situation may also further relax little by little, thanks to the recovery of the U.S. housing market and the Chinese economy7. However, while there is growing confidence that Europe is managing its debt crisis and is poised to embark on a recovery, indicators point to a region continuing to struggle to stimulate growth while cutting spending to pare deficits. Economists warn that the euro area economy may shrink for the second consecutive year and that countries like France and Spain would miss fiscal targets meant to ensure the stability of the common currency. Separately, the ECB announced that the region’s banks plan to repay less than half the expected amount of low-interest loans they took out a year ago8. The lethargic economy could set the stage for ripple effects for the United States, particularly in the financial markets.
However, experts predict that stable finances and low budget deficits, a young and growing population with an increasing level of education and domestic consumption will benefit the developing countries.
Cyprus – Should We Be Concerned?:
Until this past week, most people didn’t think much of the island of Cyprus – some didn’t even know where it was; now people know. This is very small island state with a limited number of citizens (about 1.1 million people) and a small economy ($24.9 billion in nominal GDP). For comparison purposes, the population of Ohio is 11,544,225 people with economic GDP of $460 billion. While I live in Ohio and don’t consider the State to be inconsequential, it is good to understand that Cyprus production is about 5% of my home-state.
So why the buzz? It all started with the discovery that $20.7 billion needed to be infused into their banking system. The EU came forward and offered to contribute $12 billion into the system with Cypriots needing to come up with the balance. In an economy of less than $25 billion, $8 billion is real money. Last weekend, a proposal was put forth in which depositors would (involuntarily) pay the $8 billion. The government would basically confiscate 5% - 10% of their deposits from them, giving the money directly to the banks – called a “bail-in”. Understandably, depositors across the European region were outraged. Simply taking money from depositors breaks the trust which a banking system absolutely relies upon.9
The government of Cyprus, through the blessings of the EU, was breaking that trust. The problem in Cyprus is coming down to a decision which will determine if the country stays in the ECB, utilizing the Euro as their currency or not. The system was put in place with the aim that no country is able to leave. Cyprus’ decision is putting the whole system to the test. The result: the Euro-zone markets initially staggered, then rallied later in the week as both Spain and Portugal’s bond markets raised significant levels of capital without problem. These events couldn’t have happened last year and is a sign that world investors believe the process of problem resolution is much more mature now than has been10.
In the end, it appears the Cyprus problem will be overcome, as the EU and the ECB move forward and Europe continues down the path towards political/economic/banking integration. It appears this path is the only path which the participants in Europe are able to take to maintain their union. The Cyprian problem is so small it is primarily political rather than economic. Europe is just grinding through the process of integration.
That was the Quarter that was, but now you are probably wondering how the upswing in the Market effects your 401(k) Account. First, a growth in the economy will usually mean a growth in your 401(k) account balance. In the first quarter, the Market was up 10%; this would be a great time to look at your account and see how well you fared compared to the Market. Are you currently allocated in the right portfolio for your time horizon aka Risk tolerance? When evaluating the merits of your asset allocation, it is important to recognize that not only does the initial allocation matter, but it also matters how-and how often-you change the allocation. If you are ever going to make a change, you would want to do it while on top of the mountain as opposed to looking up. Many participants realized they were invested too aggressively in 2008 & 09, but had to stay the course so they would not lock in their loss. To those people, it is time to reallocate your portfolio. Another item to consider this quarter is IRS’ 2013 increase on the annual limit on contributions to 401(k) plans is rising to $17,500 from $17,000. If you were maxed out in 2012 at 17,000 but haven’t raised your contributions to 17,500 now is a good time to consider that11. Remember, even a 1% increase in your contributions can mean a substantial growth in your retirement account.
As always, we are available at any time for individual consultations and look forward to meeting with you. Please do not hesitate to contact me directly at (216) 595-0700.