As we highlighted in the spring, 2012 has been a good year for the financial markets, equities in particular, and has exhibited much less overall market volatility than 2011. Although there were no significant year-over-year gains for equity markets in calendar 2011 from the prior year, the fourth quarter strength in common stocks set the stage for a more bullish tone into 2012. Equity markets have been going up of late, thanks largely to some improvements in economic data, including the September jobs report showed payrolls rising by 114,000 for the month as well as upward revisions in jobs growth for both August and July. More significantly, the unemployment rate dropped from 8.1% to 7.8%, its lowest level since January 20009. Although the economy does seem to have improved in recent months, growth levels in both the United States and around the world will likely remain subpar at least through the middle of next year. The base case for the United States appears to be the economy continuing to grow at around 2% (perhaps a notch higher) over the course of 2013. This growth level would be contingent on avoiding the full force of the fiscal cliff and would be underpinned by a recovery in housing and a pickup in capital spending levels. We also expect to see a steady, if unimpressive, trend of payroll gains and some additional healing in the banking sector. In such an environment, we would forecast corporate earnings growth to remain modest at best. We expect third quarter earnings to be mixed.
The second quarter of 2012 showed consistent gains in US and world markets. During the quarter the VIX Index, a measure of the volatility of the S&P 500 Index, declined 20%. Traditionally, large drops in overall market volatility mean gains for risk assets such as common stocks. This indeed was the case with steady, consistent gains from all stock markets. The S&P 500 index increased 6% for the quarter and 15% year to date, the technology laden NASDAQ Index rose 7% and 23% year to date, small cap stocks as measured by the Russell 2000 Index climbed 8% and 13% year to date, developed international markets, as measured by the EAFE Index added 6% and 7% year to date, and finally emerging markets rallied 6% and 9% year to date. These gains are welcome events for investors after all the negative headlines throughout the year and may portend future returns.
So where does this leave us looking out to the rest of the year and beyond? Overall we believe that market valuations are very low on a historical basis (although ‘fairly’ valued at current levels) and present excellent long term growth potential. We have highlighted charts in previous issues of the Guardian, but we felt it timely to include an update on the domestic housing market. While overall unemployment is still quite elevated and a drag on the economy, the housing market is improving in many respects. We continue to explore ways and opportunities to take advantage of what we believe to be a sustainable multi-year recovery in our housing markets. We have included a chart of the National Association of Homebuilders Index and Housing starts. Of note is the meaningful bounce up off of the lows of 2009, something we think can be maintained longer term.