“The world economy has stepped back from the brink and we have cause to be a little bit more optimistic. But optimism should not give us a sense of comfort and certainly should not lull us into a false sense of security.”
IMF Managing Director Christine Lagarde, March 17, 2012
The end of winter hails a transition from cold days spent indoors and the beginning of long days spent in the warm sun. There is a renewed optimism as life springs forth. And such is the state of the world economy, which underwent its own transition this quarter, giving investors cause to be a little more optimistic. Positive economic data and stabilization in Europe sent stocks soaring. The Fed gave a modest upgrade of the US economy, which seems to be on a path of slow but steady growth. There was a strong jobs report in February and the much maligned unemployment rate dropped to 8.3%. Most major US banks passed stress tests in March, which were meant to simulate disastrous economic conditions, such as a 13% unemployment rate, a 50% drop in equities and a 21% drop in housing. Major market milestones were reached, the Dow reaching 13,000 and the NASDAQ reaching 3,000. The real significance of these milestones is the effect they have on investor confidence, which could then drive markets even higher. The stock market turned in an outstanding performance, following a respectable performance last quarter. The S&P 500 is ahead 12% year to date (YTD), the NASDAQ is ahead 18.67% YTD and the Dow is up 8.14% YTD. This has been the best first quarter for the markets since 1998. GDP clocked in at an annual pace of 3% for the fourth quarter of 2011, which was stronger than expected. The Euro zone even seems to making progress as a Greek debt restructuring plan was approved.
Optimism must yield to cautious optimism as there are still threats to continued growth. One threat is energy. US energy consumption is comprised of:
9% nuclear electric power
25% natural gas
8% renewable energy
As you can see, petroleum is a large part of the pie and the concern is that as gas prices rise, growth will be sacrificed. WTI estimates that for every $10 increase in an oil barrel, it costs a quarter percent of economic growth. This is significant since our growth rate is not high to begin with. A viable US energy policy needs to be patient and consistent with the goal of producing affordable energy of scale, which takes time.
The US government’s insurmountable deficit is another threat to continued growth. As this is an election year and each candidate will have their personal spin and supposed solution to this ever growing problem, it is a good time to actually look at where we are spending. The recession increased our spending in the form of Social Security, Medicare and Medicaid costs but also extended unemployment benefits and food stamps. Stimulus packages further expanded programs and added spending on infrastructure and education. And don’t forget bank bailouts and automobile industry rescues. For approximately fifty years, defense and entitlements, meaning Social Security and health care programs, have accounted for half of the budget. The most serious issue is healthcare, which accounts for a steadily increasing part of our annual expenditures. We’re always hearing about “pork spending” but in actuality, it only accounts for .6% of the budget. So clearly, real solutions are in order.
And finally, I’m not yet convinced that the Euro zone is out of danger. The European sovereign debt crisis stabilized in the first quarter of 2012 after Greece managed to secure bailout financing and avoid default through tense negotiations. However, the yield on new 10-year Greek bonds is a staggering 21%, meaning the market is skeptical that Greece will not have to revert to bailout options. Many of the underlying issues remain within the Euro zone and it is probable that the crisis will be back in the news throughout the year.
The majority of retail investors are still not participating in the markets due to lingering fears from 2008’s crisis. This may be cause to believe there is the possibility of upward market movement in the future as these investors finally shake off their fears and add support to the rally. Only time will tell.
Please find enclosed your 1st Quarterly Portfolio Report for 2012. If you have any questions, please call me at 518-867-4245.
Olivia A. Mussett, CFP®