The financial markets in 2011 can be summarized in three words: downside macroeconomic concerns. Bill Stone, chief investment strategist with PNC Asset Management Group, said worries about big worldwide events, primarily the Eurozone crisis, dominated investors' minds this year.
The shaky U.S. economic situation set the tone at the start of 2011, with anemic GDP growth in the first half of the year.
The closing days of 2011 are a reminder of the sputtering U.S. economic recovery. It was also a year of market volatility, though it ended with stocks about even or up slightly.
On Friday, the last day of trading in 2011, the Dow Jones industrial average closed up 5.53 percent for the year at 12,217.56. The Nasdaq closed down 1.8 percent for the year at 2,605.15. The S&P 500 was unchanged in terms of price performance for the year at 1257.60. But if an investor had reinvested dividends the total return for 2011 would have been 2.11 percent, said Stone.
The "Santa Claus rally" usually brings a gain in stocks in the last five trading days of the year through the first two trading days of the new year. This year, the rally was muted in the last five days.
So far the S&P 500 is up a little less than 0.3 percent.
"While Santa still has two trading days left, he better hurry since this return is significantly lagging the 1.6 percent average return since 1969 for these seven trading days," Stone said.
The economic recovery has had robust aggregate demand, largely from consumers, but was full of fading positive sentiment, LeBas said.
These seven trends and events in 2011 illustrate why investors were on edge this year:
1. Positive Companies' Earnings Not Enough to Encourage Stocks
Although earnings for the companies in the S&P 500 rose about 15 percent in 2011, the market was roughly flat. This means that companies' stock price-to-earnings, or valuation, ratios actually compressed in 2011.
"This certainly points to worries about the future path of earnings and the global economy being a primary driver," Stone said.
2. Investors Flocked to "Safe" Treasury Bills
Despite the downgrade of U.S. government debt and inflation running at 3.4 percent, according to the consumer price index for the year through November, the 10-year U.S. Treasury yield is below 2 percent. This is even below the level it ended 2010, which was 3.29 percent.
"Investors were willing to accept a negative real return, after-inflation, in 2011 as the "flight-to-safety" drove them to U.S. Treasuries due to concerns about the macro environment," he said.
LeBas, who covers the bond markets, said it was a "satisfying trend."
"Once again, the bond markets prove that commonly held perceptions are the most dangerous thing in the financial world, as despite forecasts of a large increase in interest rates, Treasury yields are 1 percent or more below 2010's finish," he said.
3. Macroeconomic Concerns Stir Stock Prices
The correlation of stocks' movement in the S&P 500 reached new highs in 2011, surpassing even levels seen after the October 1987 stock market crash. (See chart below.) In other words, stocks in the S&P 500 moved very much in unison indicating that the "big picture" was driving stocks rather than individual company metrics, Stone said.
4. Overreacting to Events Abroad
LeBas said a variety of over-hyped events led to anxiety and sometimes negative reaction in the financial markets.
The most "meaningless event" was when investors stayed up to watch the results of a confidence vote for Greek Prime Minister George Papandreou in July as an indicator of where the European situation was leading. He was eventually replaced by Lucas Papademos, former governor of the Bank of Greece and vice-president of the European Central Bank.
5. Political Squabbling Frustrates Investors
LeBas called the recent debate in Congress arguing over a 60-day extension in the payroll tax cut, "useless."
"As if a company would make a hire/no hire decision based on two months of taxes," he said. For an employee earning $50,000, that tax cut extension saved $167, or about what the average commuter would pay in gasoline over those same 60 days.
6. Downbeat Economic News
When the U.S. lost its top credit rating in August, it was a psychological blow rather than a real one, as the markets largely shrugged off S&P's downgrade. Still, LeBas called it a "depressing development."
7. Unemployment Drags on
A slack labor market remains the biggest long-term challenge for both consumer spending and aggregate demand, according to LeBas. Given the pace of job growth, full employment remains five-plus years away, he said.
In Janney Capital Market's 2012 economic outlook, LeBas said we can look forward to the following:
1. European powers seem to show little willingness to bring out the European Central Bank's "bazooka" to deal with the more acute critical problems facing the Euro. That lack leaves an overhang above risk assets.
2. Banking sector distress stemming from European sovereign distress is having a measurable impact on banks' willingness to provide credit, thereby presenting a 50/50 recession risk.
3. Despite this almost inexplicable consumer stability, the U.S. economy continues to lack any inspiration that could drive growth to escape velocity, suggesting 2012 will be at best a year of slow growth, replete with a risk of recession.
4. The first round of federal spending cuts are slated to go into effect in 2012, and baring an unlikely watering-down of budget control provisions, we expect headwinds from knock-on effects.
5. Monetary policy is no longer able to effectively support growth, as shown by the failure of the Federal Reserve's "quantitative easing" measures to meaningfully increase the "real" money supply or otherwise stimulate borrowing demand.
6. With consumer trends less-than-impressive and commodity price hikes now behind us, inflation is moderating. The first potential for acceleration may be in 2015.