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The Sandy Spring Way

January Observations

January 9th, 2012 | By Beau Mercer

“I can see clearly now, the rain is gone; I can see all obstacles in my way; Gone are the dark clouds that had me blind, It’s gonna be a bright, bright, bright, sun shiny day…” —Johnny Nash

Weather forecasting is slightly more refined that astrology. Examine the pressure patterns or look at the stars and hope your prognostication is right.

The economy was weak in 2011, but it ended better than it started, with growth up from its lows and unemployment down from its highs. When data is released later this month, economists expect growth of around 3% for the fourth quarter of 2011, compared with 1.2% on average for the first three quarters. The President, members of Congress and many noted market strategists describe 2012 as another ‘muddle thru’ and the media has done a fine job of explaining the continuing economic demise. Can news flow disappoint to a greater degree than it did in 2011?

Let’s prognosticate! Will 2012 be the year in which investors regain their confidence? I am of the opinion that the US economy will gradually improve over the next 12 months. Further, I expect consumer confidence to reflect a better economy, but the road ahead will be bumpy. Confidence is a psychological phenomenon and can make capricious jumps up as well as down.

The monthly Consumer Confidence Index quantifies how the consumer views his or her financial health and spending. The December rise in the Consumer Confidence Index was recognized by the retail sector as sales surprised on the positive side. Nevertheless the disconnect between consumer confidence and equity investment persisted in 2011. But that may change in 2012.

Keynes in his 1936 book “the General Theory of Employment, Interest and Money” refers to the sense of trust we have in each other, our sense of fairness in economic dealings, and our sense of the extent of corruption and bad faith. Keynes referred to that sense as ‘animal spirits’. When animal spirits are on the ebb, consumers do not want to spend and businesses do not want to make capital expenditures or hire people. Seemingly, reigniting animal spirits will require a herculean leap of faith and the extreme volatility (lack of confidence) of the markets highlights the challenge. According to Morningstar, stock mutual fund managers in 2011 lost 3.2% in their attempts to avoid market whipsaws. The overriding question in 2012 is who or what will restore investor confidence. In 2011, investors had to deal with three distinct macroeconomic crises: Congressional partisanship, Arab Spring, and the Sovereign Debt contagion through Europe. All three of these events were enough to knock the market down, but the global economy was resilient enough to keep growing. Obviously, all is not right for the world’s economy, but there is light in the US stock market.

There are reasons to be optimistic in 2012. The stock market continues to be an exceptionally efficient mechanism to transfer wealth from the impatient to the patient. Stocks remain attractively valued compared to historical valuations of bonds. Based on earnings trends, which remain positive, low interest rates and an expected downtrend in the dollar, confidence in the stock market can improve and above average companies can be bought for less than average companies. The improvement is supported by lyrics that include reduced unemployment, increased capital investment and minimal inflation. I CAN SEE CLEARLY NOW!

—Fred