The domestic stock market, as measured by the S&P 500, posted a lackluster return for the quarter, but it achieved that return in spectacular fashion. At the mid-point of the quarter, roughly 10 days after the Presidential election, the market was down 6%. The market rallied from that point forward—capped off by a strong closing kick on New Year’s Eve fueled by rumors of a compromise on the Fiscal Cliff negotiations in Washington. Ironically, it was Apple, a stock that was up 65% over the first nine months of the year, which dragged the index returns down for the quarter. As the largest company in the world, Apple had nearly a 5% weight in the S&P 500—its 20% decline for the quarter accounted for all of the index’ decline and then some.
Global stock markets performed much better than the domestic market in the fourth quarter. This was largely due to an easing of concerns regarding the European sovereign debt crisis and rising fears of the domestic Fiscal Cliff. While the S&P 500 was down 0.38% for the quarter and domestic small-cap stocks were up only 1.85%, emerging international market stocks were up 5.58% and developed international markets were up 6.63%. Domestic taxable bonds were up 0.24% for the quarter, municipal bonds were up 0.21%, and taxable international bonds were down 1.04%. Despite all the craziness and the rollercoaster ride the markets gave us throughout the year, 2012 turned out to be a very good year for investors. Domestic stocks returned 16% for the year, global stocks were up 16.8%, taxable bonds were up 4.3% and tax-exempt bonds were up 3.1%.
Our clients’ portfolios benefitted from an increased allocation to small- and mid-cap international equities, as well as our introduction of a new frontier market (Africa, Middle East, etc.) investment in the portfolios. They were hurt by a couple of our higher yielding asset classes, mortgage REITs and energy infrastructure MLPs, that were star performers for us in previous quarters. Much of the damage was due to speculation about rising dividend tax rates, which we felt was being misapplied even if rates had gone higher, but is now a moot point. In any event, both of those asset classes have come roaring back in this first week of the new-year.
The New Year brought a compromise from Washington in one area of uncertainty: future tax rates; and, the markets have rallied on that news. There are still the matters of spending cuts and expansion of the debt ceiling—those discussions will likely get ugly. That said, market fundamentals strongly favor stocks over bonds—the dividend yield of the S&P 500 is 0.5% higher than the yield on investment grade taxable bonds; price-to-earnings multiples for stocks are nowhere near overextended levels; and, inflation pressures are beginning to build as each major central bank devalues their respective currencies. As a result, we will look to use any meaningful equity market pullback over the next couple months as an opportunity to reallocate from fixed income-like asset classes to global equities and real assets. We remain committed to our mandate to build the least risky portfolios necessary for our clients to achieve their financial goals.
Chief Investment Officer