2011 was a very volatile year, even though the year finished virtually where it started, at least as measured by the broad-based S&P 500 index. While price change on the index was flat, adding dividends resulted in a return of 2%. However, those investing in smaller- to medium-sized companies experienced modest declines, with international stocks registering losses in excess of 10%. The winners were bond investors, with intermediate bonds generally returning 7% to 10% for the year. While the economy may be slightly better in 2012, expect returns by investment classes to be significantly different in 2012.
2011 finished on an upbeat note, as 200,000 jobs were added in December, and new jobless claims are at their lowest level in several years. In addition, auto sales were near their best level of the year for the month of December. For 2012, expect moderate job creation, though the unemployment rate will remain relatively high. With a better labor market, wage gains should improve somewhat and new college graduates might find obtaining a job a little bit easier compared to recent years.
Inflation should remain relatively low this year, though there will be some shift in its components. The more volatile food and energy costs should moderate in 2012, with a stronger U.S. dollar, which lowers import costs, notably for oil. The price of oil is relatively high currently, near a $100 per barrel, due in part to tensions with Iran, but overall, the worldwide supply of oil appears adequate, which should help alleviate future price increases. Food prices are always subject to the vagaries of weather, but basic food commodities have stabilized in recent months, boding well for future food inflation.
The real estate market continues to appear dormant but there are a few glimmers of hope. Home builder stocks have been strong performers the last few months, which could be a sign of a turn in the new home market. Also, apartment vacancies are at their lowest level in several years, which would imply further rent increases. Low mortgage rates, higher rents and a better job market should result in better housing demand. On the Westside, with relatively high house and condo prices, the impact might be more limited compared to the rest of the country and inland California.
With regards to investments, bond investors are unlikely to match their 2011 returns, unless interest rates continue to drop, which is unlikely, with the 10-year Treasury yielding 2%. The U.S. stock market should perform reasonably well, as long as Europe does not cause a global financial crisis. Emerging markets appear to offer the most upside given relatively inexpensive valuations and strong growth prospects. Emerging markets are not for risk-averse investors but are certainly suitable for a portion of an investor’s portfolio with a long-term perspective.
Any year will bring unexpected developments, which is why it’s important to remain diversified. However, except for those who are very risk averse or have a short-term time horizon, the relative attractiveness of stocks appears to be better than bonds in this very low-interest rate environment.
