As Published in the Winter 2012 Edition of NJ Lifestyle
The Year 2011 was a historic year in many respects:

  • Protest, social unrest and change in Northern Africa and the Middle East
  • The death of Osama Bin Laden and the end of the Iraq War
  • The elevated risks of the on-going sovereign debt crisis in Europe
  • Removal of the Unites States AAA credit rating by Standard & Poor’s
  • US Congress gridlock, including the debt ceiling debacle
  • Occupy Wall Street movement

For equity investors, it was an extremely volatile year that by the last day of December left the S&P 500 unchanged, small cap (-5%), mid cap (-3%), developed international (-15%) and emerging market (-20%) indices all negative for the year. Interest rates ended the year even lower than they began, which resulted in a surprisingly good year for fixed income. Ultimately, investor’s returns were determined according to their specific asset class allocation and weightings, including their own exposure to equities, fixed income and precious metals. US equity performance was influenced by the following:
Corporate Earnings vs. Geo-Political Negativity
Despite all of the headline news that inundated 2011, US Corporate earnings were actually good. So good, in fact, that if you look at the S&P 500 returns in just the four months when companies reported their earnings (January, April, July and October) the S&P 500 was up almost 14%. The problem was in the other eight months the news was dominated by the European Debt Crisis, mixed economic news and Washington political wrangling, resulting in mostly negatives for the market. Conversely, during these eight months, the market was down about 14%.
Growth vs. Value
This term refers to two styles of investing based upon specific company attributes. A growth company is a company that exhibits signs of above-average growth in terms of sales growth and corporate earnings, even if the underlying share price appears expensive in terms of metrics, such as price-to-earnings ratios. Typically, these companies reinvest their earnings in their business as they are generating high returns on capital. These tend to be companies generally early in their life cycle. Most, if not all, of an investor’s return from a growth company comes in the form of stock appreciation. In general, these stocks did not do well in 2011. Value investing generally involves buying securities whose shares appear underpriced by some form of fundamental analysis. These stocks may trade at discounts to book value, have high dividend yields or have low price-to-earnings ratios. These companies tend to be more mature and further along in their life cycle. Because they often cannot generate an above average return on capital, they choose to return capital in the form of dividend payments to their shareholders. These companies often tend to be defensive in nature, as investors are more likely to hold on to them in flat or negative markets because they are providing a source of cash income. With the incredibly low level interest rates reached in 2011, many investors turned to these companies for the income they produce, as many blue-chip companies have dividend yields well north of 3% (compared to a 10 year US Treasury note yielding less than 2%). Consequently, many blue chip dividend payers did well in 2011.
Sector Weighting
The financial sector of equity markets underperformed, whereas consumer discretionary, utility and energy shares all out performed. So far, 2012 is off to a good start, with most international and domestic equity markets rallying. Unfortunately, many of the issues that grabbed headlines in 2011 still remain unresolved, which points to further volatility in the months ahead.