January 2, 2012
David R. Kotok
Looking eastward from my 12th floor Sarasota condominium, one sees the cityscape and then a long view of South Florida’s flat landscape. Greeting sunrise has become a habit. The winter solstice season is best.
Fireball sun rises between buildings. My gaze crosses the level expanse of Florida. The dawn light brightens into yellows and oranges and reddish hues as the giant fireball prepares to peek above the morning ground fog that is prevalent this time of year. Norah Jones’ sultry, seductively sweet “Sunrise, Sunrise” greets Fireball as I hit the play button.
The New Year’s balcony view puts Fireball in a special sandwich. The bottom is the Florida landscape. The top is a cloud layer. As Fireball prepares to emerge, the band of light between landscape and clouds is the brightest orange in the spectrum.
7:19 AM. Fireball heard Norah Jones’ call as it slowly but steadily heaved itself up and filled space. The spinning Earth tumbles forward to deliver the perfect moment. Glorious Fireball shines forth.
The Earth spins on. Fireball seems to rise behind the clouds and begins to disappear, masked by the gray mass.
Oh, how I wanted to reach out and help Fireball get up and through the clouds. Imagine yourself watching this unfold; imagine extending your hand across the miles, reaching under Fireball and gently assisting its upward struggle.
Fireball was lost in the clouds. The mammoth orange orb was history. The narrow cleft between land and cloud radiated a residual, yet dimming, glow from Fireball’s opening appearance of 2012.
Sunrise 2012 greets us with questions. Will it be a year of positive outcomes or a year with only brief, bright interludes sandwiched between gray, cloudy masses and misty, obscuring ground fogs?
Let’s reflect on that for a minute or two.
2011 started out like our rising sun metaphor. The market rose, along with optimism about the US economy. The market peaked on April 29. Europe’s turmoil and uncertainty about the US recovery triggered a 5-month, 20%-down, bear market. The sell-off became serious, and in early August we witnessed a selling climax. The climax was retested several times and a final low was established on October 3. Since then the market has recovered robustly and broadened. If you looked at the S&P 500 index on Jan. 1 and then took a trip to Mars, you would have missed the show. You returned on December 31 and found the market at exactly the same level as when you departed.
Fed policy this year is likely to be benign. Bernanke’s term is up in 2013, so the latter half of that year could witness changes. That is then, and the present course of monetary policy seems to be set. Furthermore, any shock that injected risk into the US economic recovery could and would be met with additional monetary stimulus. In 2012, Bernanke has the majority support of the FOMC voting members. We expect no change in Fed policy during 2012.
This bodes well for US markets. Tight money can kill a stock market recovery. Easy money rarely does.
US political risk is high. The Iowa circus has put on display the dubious nature of some of the characters who aspire to be our next president. So far, they have succeeded in raising the ratings of Obama. Nevertheless, politics are fluid and volatility surrounding the election is to be expected. Maybe the market transitions in 2012 will mirror 2011 as the political cycle and market cycle become congruent and mature in November?
We expect some early strength in US stocks. We see the earnings rate for the S&P 500 at about an $100 run rate. That puts the market at less than 13 times earnings. Those earnings support a dividend yield higher than the riskless ten-year treasury yield. The equity risk premium is very high. US stocks look cheap by many measures.
Granted, the profit share of GDP is higher than the historical norm, but the real question is what will cause it to shrink. It won’t shrink from labor-cost pressure when the unemployment rate is so high. It won’t shrink from high financing costs when interest rates are so low. Moreover, it won’t shrink from inflation pressures when inflation is benign.
In other words, the case for a bear market is weak as 2012 unfolds. Could this change? Of course. Will it? We do not know. Shocks come from many sources. They always do.
We enter 2012 fully invested in our US stock portfolios, using exchange-traded funds. What happens as the year progresses remains to be seen. We hold to an interim target of 1350-1400 for the S&P 500 index. Our longer-term target is 2000 by the end of this decade.
And now, in this moment, we welcome the sunrise.
David R. Kotok, Chairman and Chief Investment Officer