In the fourth quarter of 2012, the US stock market, as represented by the Standard and Poor’s Five-hundred stock index, fell 1% to 1426 on worries surrounding political dysfunction in  Washington, DC.  For the year, stocks rose 13.4% as the US economy performed better than expected, the European financial crisis stabilized, and the US Federal Reserve continued extraordinary policies to support financial markets.  The yield on the benchmark ten-year Treasury note closed the year at 1.76%, up 12 basis points (hundredths of a percent) on the quarter and down 11 on the year.  The Federal Reserve’s intervention in the Treasury market kept yields relatively stable throughout the year.  The price of gold declined 5.5% for the quarter to $1,675 per ounce, but increased 6.9% for the year.  As with stocks, the inflationary implications of stronger growth and accommodative monetary policy were tempered by the prospect of deflationary fiscal policy coming out of Washington in 2013.  Oil closed unchanged for the quarter at $92 per barrel.  For the year, the price of oil declined 7.1%.  Decreased fears of a potential war with Iran helped guide the price of oil lower.

As mentioned above, three factors supported US stocks in 2012.  To begin with, the US economy performed better than the general Wall Street consensus.  Strength in important sectors of the economy such as jobs, automobile production, and construction and housing has exceeded investor expectations.  Barring a self-inflicted wound by Washington we believe the economic recovery in the United States is both real and self-sustaining.  Turning overseas, the European financial crisis stabilized, at least temporarily, in 2012.  In a July speech, European Central Bank president Mario Draghi said he would do “whatever it takes” to insure the integrity of the Euro currency.  He followed up with a credible plan to stabilize the sovereign debt markets of distressed Eurozone members.  While the Europeans have a long way to go to insure the long-term viability of the Euro currency, the current environment is undeniably an improvement over recent years.  Given its close economic and financial ties to America, a financial calamity in Europe would be very bad for American markets.  Finally, the US Federal Reserve continued its extraordinary efforts to support the economy vis-à-vis the financial markets.  The Fed has committed itself to buying $85 billion of Treasuries and mortgage bonds per month until either the unemployment rate falls to 6.5% or the inflation rate rises to 2.5%.  By removing so many long-term assets from the market on a continuing basis, the Fed is essentially pushing investors into riskier assets such as stocks, corporate bonds, and real estate, hoping that rising asset prices will make people feel wealthier and increase spending.  While there is much partisan debate surrounding the wisdom and efficacy of this policy, we believe it is having its intended effect of supporting stock prices.

Although these factors were supportive to stocks throughout 2012, the market declined in the fourth quarter due to the renewal of partisan warfare surrounding US fiscal policy.  The latest edition was the so called “fiscal cliff” that represented the potential of $600 billion of tax increases and spending cuts in the coming year.  Investors remember the nearly 20% decline in the S&P 500 in the summer of 2011 over the debt ceiling crisis and were weary of a repeat performance.  Although the parties have once again managed to avoid outright policy failure by modestly increasing taxes and delaying spending cuts, the partisan vitriol and brinksmanship do not inspire confidence going forward.  To wit, another damaging showdown on the debt ceiling is likely in the coming months.   That having been said, from a stock market perspective, this agreement minimized the potential impact on investment income.  Taxes on capital gains and dividends will only rise from the current 15% to 20% for individuals making more than $400k and joint filers more than $450k.

Looking forward into 2013, we think stocks can have positive returns unless US politicians derail the American economy through continual fiscal brinksmanship.  Other risks to our forecast would be a return of the European financial crisis and possible conflict with Iran.  In addition to the economic momentum we discussed above, a positive story to watch for regarding the US economy and American business will be the continuing development of domestic “shale” oil and gas production.  This has the potential to substantially increase the economic competiveness of the nation through lower energy prices and a positive impact on our balance of trade.  With the Fed active in the Treasury market, we feel bond yields will remain relatively stable in 2013, although at the current low yields, we continue to believe that long-term bonds are a poor investment.  (We currently invest only in short-term bonds.)  This same accommodative Fed policy should also be supportive to gold.  Oil will remain largely dependent on geopolitical risks emanating from Iran’s nuclear ambitions.  We feel global supply and demand are basically in balance at the current price.  For 2013, we see the S&P 500 stock index trading in a range of 1350 to 1600.  It closed 2012 at 1426.

For the third year running, we are pleased to have been named a Five-star Wealth Manager as described in Chicago Magazine.   Fewer than 3% of the 11,800 financial services professionals in the Chicago area are chosen.  A detailed description of the award can be found on pages FS 1 and FS 2 of the November, 2012 issue of Chicago Magazine.

We appreciate your continued business and the trust you have placed in us. Do not hesitate to contact us with any questions or concerns you may have. We hope you have a happy, healthy, and prosperous new year.