As 2012 draws to a close, it becomes important to evaluate what to expect for next year. This past year has turned out to be a good year for financial markets.
The broad based S&P 500 has had a total return of 17 percent through last Friday, clearly a lot better than a money market return.
The new year will certainly bring a lot of question marks. The fiscal cliff still needs to be resolved.
I don’t think it will make much difference whether an agreement is reached at the end of this year, or early next year. The key thing is there will be an agreement, even if it is temporary in nature.
It is virtually certain that taxes will be going up, which will act as a depressant on the economy. The Social Security tax, which has been reduced 2 percent points for employees the past two years, is scheduled to go back to its prior level in 2013.
There have been discussions about extending that tax break, but it is uncertain what will transpire. That tax impacts most workers, except for certain government employees.
The bulk of the discussion between the President and Congress concerns taxes on higher income individuals.
The President wants higher taxes on single people earning over $200,000 and married couples with income over $250,000.
The Republicans have countered that higher taxes should just be on those earning over $1,000,000. In addition there is talk about limiting deductions for higher income people.
Higher tax rates do not always increase revenue, as individuals may change their work effort when taxes increase. Also higher taxes on small businesses, who normally increase jobs more than large companies, would tend to limit employment growth.
Limiting deductions would have less impact on employment, though industries that benefit from deductions, such as Real Estate would fight changes.
Higher taxes will likely only have a minor impact on reducing our large deficit. However, if they are coupled with meaningful spending cuts then some progress on reducing our deficit could be accomplished.
There are some positives to consider for next year. A major one is an improving Real Estate market. Real Estate had been a depressant on the economy for a number of years, but in 2012 we finally saw improvement on a national basis.
With inventory levels low, and household formation expected to increase with modest employment gains, I would expect Real Estate to contribute to GDP growth in 2013.
Auto sales should also be a positive contributor to the economy next year. 2012 has been the best year, since the Great Recession, and there is significant replacement demand, as the age of cars on the road is at record high levels.
The international arena, which is very important to U.S. multinational companies, should be mixed in 2013. Europe will continue to be a problem area, but will likely not be any worse than 2012. The rest of the world should see moderate growth, which provides opportunities for U.S. exports.
On balance I think the economy will continue to exhibit slow growth in 2013, just as we have seen this year. A slow growth economy will likely translate into modest earnings growth for the stock market.
It is unlikely 2013 will bring the market returns we saw this year. However, with money market returns still near 0, and high quality intermediate bonds yielding near 2 percent, the stock market still looks reasonably attractive compared to other alternatives.