What have we accomplished in the past year? As a country, as a society, as a global economy, what progress have we really made? And what are some achievable goals for 2012? Year end is always a good time for reflection.
In the December 2010 edition of Willingdon Views, I posed this question – “…what are the chances that a divided congress will work together to make meaningful and lasting progress toward reducing our trillion dollar federal deficit?” More broadly, how have we done in this country in terms of working together? Not so well would be the short answer based on the Occupy Wall Street movement, polarizing political rhetoric, and the threat of class warfare. In 2011 I learned a new word – Brinkmanship. It’s a disparaging word, an antagonizing word, a downright grotesque word. Worse over, it might be a defining word for 2012 as well.
Many of the same challenges we faced going into 2011 confront us today, including: too much global debt, stubbornly high unemployment, decaying infrastructure, and an alarming expansion in government spending. It is hard to argue we’ve made any meaningful progress toward solution in any of these areas. 2011 has been a year of blame, of sweeping problems under the rug, and of that ugly word, brinkmanship.
Not surprisingly, the stock market is likely to end the year about where it started, despite corporate profits growing close to 15%. The price/earnings ratio has declined to around 12x, well below the average PE of 15x. At the moment, the consensus is predicting 8% growth in corporate profits in 2012. As long as earnings estimates are achieved, the stock market, generally speaking, is statistically cheap. Perhaps, a glimmer of hope…
The catalysts that were in place for a strong stock market in 2011 are also in place today. The progress, or lack thereof, in two critical areas will largely drive the markets in 2012. The first is the situation in Europe related to sovereign debt woes, slow economic growth, and uns
ustainable government spending. The second is the November election, which may be the most pivotal one in our lifetime.
Over the next several months, if not longer, I suspect there will be periods where progress in Europe seems evident, only to be followed by periods where the ultimate demise of the European Union seems inevitable.
Meanwhile, in the U.S., there is an outside chance that as fall approaches the polls may portend a more business friendly outcome from both the presidential and congressional elections, but I don’t think that is likely. A more probable scenario is that the level of uncertainty and polarizing rhetoric will escalate throughout the year, ending with our country perhaps even more divided post election.
Make no mistake, an election result that leads to more government spending and higher taxes would be decidedly negative for the market. Conversely, an election outcome that gives new hope to the prospects for a reduction in government spending and lower overall taxes would likely be greeted with a very powerful market rally. And until the end result is known, the market will have a tough time making headway. So, our journey forward has been, for the moment, delayed, leaving our country at a crossroads. In Robert Frost’s famous poem, The Road Not Taken, he pens -
I shall be telling this with a sigh
Somewhere ages and ages hence:
Two roads diverged in a wood, and I—
I took the one less traveled by,
And that has made all the difference.
One can only imagine what the road less travelled might look like for the United States over the next several years. What is our destination and what will we witness along the way? Will the 1% earn the respect and inspiration of the 99%, through leading the cause to end crony capitalism and political corruption? And will the 99% embrace the free enterprise system by harnessing anew the American work ethic and entrepreneurial spirit that once built the greatest nation in the history of the world? And most importantly, can we all travel this path together? Truly that would be a road less traveled.
So, we enter the New Year cautious, with significant dry powder, but we are ever vigilant for valuation opportunities, in what is likely to be another volatile year for the stock market.
Above all we wish you a very Merry Christmas and a joyful holiday season.
Michael Kayes, CFA
