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Stocks – 2012 Recap / 2013 Outlook

Posted by Eric Anderson on January 27, 2013

eric_f.jpegDespite a choppy 4th quarter, equities delivered strong returns during 2012.  During the last quarter of the year, larger capitalization stock returns were modestly negative, and the pullback was primarily concentrated in the Technology and Energy sectors.  Specifically, over the last three months, the S&P 500’s total return was modestly negative at -0.4%, while the Dow Jones Industrial Average dipped -1.7%, and the NASDAQ slipped -2.5%.  However, small capitalization stocks, as demonstrated by the Russell 2000 index, rose +1.8%, while the big move came from overseas, with the international equity index MSCI EAFE gaining +6.6%.

For the year as a whole, all of the major indices that we track delivered double digit performance with the best results coming from MSCI EAFE which gained +17.9%, and the weakest results were delivered by the Dow Jones Industrial Average which gained +10.2.  The NASDAQ was ahead by +17.7%, while the Russell 2000 small cap index rose by +16.3% and the S&P 500 returned +16%.  A considerable amount of the Dow’s relative underperformance to the S&P 500 can be traced to investors favoring more growth oriented stocks in 2012 over the more established large blue chips that also pay attractive dividends, which dominate the Dow’s 30 company roster.  This shift in leadership represented a big shift in strategy from the prior year, when the Dow handsomely outperformed the S&P 500 during 2011.

All ten of the S&P 500 sectors delivered positive returns during the year, and interestingly the strongest results came from the Financials which were up +29%.  The group began the year under pressure, as they had been the weakest sector during 2011 losing 17% of their value, and their stout increase in 2012 represented a complete turnaround from its prior year results.  In addition to the Financials, three other sectors had both strong absolute and relative performance, with the Consumer Discretionary increasing +24.1%; Telecommunications rose +18.3%; and Healthcare was up +17.9%.  The Industrials, Technology, and Materials sectors all had similar results that were clustered around the +15% level for the year, while the two remaining sectors lagged by a notable amount.  Specifically, the Energy sector returned +4.6%, and the Utilities were barely positive, increasing +1.3%.  The flip side for the excellent returns for the Financials in 2012 compared to the worst returns in 2011, was experienced by the Utilities with the worst returns in 2012 and the best sector in 2011 returning +20%.

 It has taken five years, but the S&P 500 is now higher than its prior peak.  Specifically, at the end of 2012 the index was 2.3% higher than its pre-housing-and-credit-crunch peak level in October 2007, and 70% of the index’s sectors are also higher than their prior peak.  Of the three sectors that are still below their peaks, two are only modestly lower, with Materials down by just -0.6% and Industrials off by just -1.4%.  However, despite their strong showing during 2012, Financials are still 49% below the 2007 peaks, as the sector which continues to work its way back from the excesses of  leverage from the past credit cycle.

Stocks were stronger in 2012 than most market strategists had forecasted they would be, given the economic slowdown that was taking place around the world.  The markets in 2013 are starting off the new year with this same momentum but we would expect a pause sometime this spring as it becomes apparent that the various fiscal drags have slowed the U.S. GDP growth to below 2%.  We are however still constructive on equities especially given their more attractive valuations on a relative basis over longer term fixed income opportunities.  For the year as a whole though, we do not expect the same level of returns from stocks that they delivered last year.