It was about as close to zero return as it could get, with the S&P 500 closing the week (and day) down slightly, adding a little drama on the last day of a year that had already had WAY too much drama. A year ago, the market had closed at 1257.64. Today? 1257.60. It doesn't get any closer! Of course, with dividends, the S&P 500 was able to post a gain. Here's how the models look as of this evening:
Top 20 lost about 0.5% during the very quiet week, slightly less than the S&P 500. Unfortunately, while we closed the year with a strong month (up 2.9% compared to the 1% rise in the S&P 500), the model modestly underperformed the market over the last three months, rallying about 11% compared to the 11.8% return by the S&P 500. For the year, the model lost a little over 3%, while the S&P 500 gained a little over 2%. One of the big challenges this year was the persistent weakness of smaller stocks, as the Russell 2000 Small-Cap Index declined over 4%.
Conservative Growth/Balanced also lost about 0.5% during the week, but this was worse than its index (60% stock/40% bond). Our stocks declined slightly more than the S&P 500, and we are overweight. On the other hand, we are signifcantly underweight bonds, and they rallied during the week. For the month, the model underperformed its benchmark by about 0.7%. For the quarter, the model lagged by about 0.1%. For the full year, the model ended up essentially tracking the index, returning a little over 5%.
Sector Selector ETF matched the S&P 500 this week and underperformed by about 1.4% in December as Emerging Markets lagged sharply. For the quarter, SSETF grew 12%, slightly ahead of the S&P 500. We launched SSETF right at the peak of the market in late April, and the model was never positioned very well during the year. The bulk of the 3.8% underperformance took place in August and September. Over the past few months, we were able to restructure the model such that it is substantively different from how it looked at the launch, with an even more aggressive posture that I believe properly reflects the better valuations.
Market Outlook
When I discuss each of the models later this weekend, I will integrate my outlook. I haven't changed my view, which I have discussed extensively over the past few weeks. I continue to view the market as very inexpensive from a valuation perspective that seems to more than compensate for some challenging macro factors. Fundamentals seem modestly positive - our economy remains in a recovery from a very deep recession and shows no signs of excess. We have way too much slack - plenty of firepower to grow the economy, if only we can better use our resources. High unemployment is really our biggest challenge, and improvement in the labor markets, which is slowly underway, is the single most important factor in my view (except, of course, for what's going on in Europe!).
I was very bearish in 2007 despite "cheap" stocks - the economic expansion was too mature. We also hadn't experienced a pullback of more than 10% since the early 2003 lows. Today, I find the technicals much more encouraging. We have now had two very deep corrections to the rally that began in 2009. Skepticism abounds. I know that my optimism proved unwarranted in 2011, but I view the market as insanely inexpensive today as I viewed it expensive in 1999. Of course, it rallied in 1999, but, in retrospect, it was expensive, especially the larger companies.
The technical set-up today is quite apparent in my view: The long-term up trend from 2009 is intact. The 2nd correction ended in early October, and we have been consolidating the bullish break from the lows subsequently. I expect that 2012 will look very different from the past two years, which were remarkably similar in many respects. 2010 and 2011 saw late-April peaks followed by the lows of the year in the last four months. 2010 bottomed at Labor Day, while 2011 bottomed about a month later. Q4 was strong for both years. The biggest difference, of course, is that we closed at new highs in 2010, while we struggled at the flat-line in 2011. I expect a strong start to the year and a strong finish presumably. We might stall out somewhere in the middle, but I don't expect a 20% pullback like we endured the past two years.
2012 is an election year, which will provide a lot of focus. I find it very difficult to integrate the political outlook this year, one way or the other. On the one hand, I can see optimism regarding Obama potentially ceding the White House, but I can also see Obama making a potential "bold move" to try to cement reelection. In any event, while I don't mean to minimize the potential impact, I do think it's very unclear.
So, to repeat my previous outlook: I think we could have a big rally this year. I shared a view that 1600 on the S&P 500 (up 27% from the 1257.60 close) is achievable, based on modest earnings growth and some PE expansion. My target is based upon the market trading at 14 PE a year from now. For this outlook to work, we will most likely see improvement in our employment outlook and more optimism about the downside risk from the European financial challenges. In this scenario, longer-dated Treasury rates are likely to climb, with some pressure on other interest-rates as well.
As this year proved, though, I have no crystal ball. The first four months tracked my forecast very well despite the shock of the Japanese earthquake and tsunami. Even as late as early July, we seemed on track. My 2010 forecast proved highly accurate, but the market did much better than I expected in 2009. I share my views because they do influence portfolio construction, especially for CG/B and SSETF but also Top 20.
Articles (all on Seeking Alpha)
- Small-Caps Should Rally in January
- Potential Bounce Candidates
Final Thoughts
While I didn't achieve my goals with the models in 2011, I am optimistic that 2012 will prove to be significantly more fruitful. I know that not only was I not alone in my struggles this particularly challenging year, but that I continued to make the necessary effort and to stay true to my discipline. One of the biggest challenges all of us have is stay with our methods when they are clearly not working. I made a lot of mistakes, especially not having a better respect for the rapidly changing market in late July and early August. It could have been worse. In both Top 20 and in CG/B, the results for the year were aided by changes made to the models during the year (more on this in my full review). So, with a little humility and a lot of disappointment, I also want to express my gratitude to all of my subscribers. May 2012 be a great year for us investing but, more importantly, a happy, healthy one for you and your families.
Regards,
Alan Brochstein, CFA
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