Q4 2011 Letter
We hope you enjoyed a restful holiday with your family and are off to a great start to 2012.
We’ve attached two documents to this letter: the first reviews our economic themes for 2011 (evaluating where we were right and where we were wrong) while the second outlines our investment themes for 2012 (topics we think will have the biggest impact on client portfolios in the coming year).
The fourth quarter of 2011 saw US stocks recover sharply from the mid-summer selloff. The S&P 500 (the broad measure of US stocks), which had ended the third quarter at 1,131.42, finished the year rallying up to 1,257.60, a gain of over 11%. Despite these gains, the S&P 500 finished 2011 virtually unchanged at -.11% (when dividends are factored in, the return was a positive 2.11%). The Dow Jones Industrial Average (the index that tracks 30 blue chip US stocks) finished the year up 5.5% (8.38% with dividends), which was in line with our investment thesis of buying large cap dividend paying US stocks. The Nasdaq (the tech heavy index) finished 2011 lower at -1.8%.
The Nasdaq losses were minor compared to stock returns overseas. While the losses in the UK were modest (the FTSE 100 finished down only -2.18%) due mainly to the strength of the Pound, countries in the European Union fared far worse. Germany (DAX) finished the year -14.69% and France (CAC 40) saw a return of -14.28%. The so-called BRIC countries (Brazil, Russia, India, China) – those emerging market powerhouses that seemingly sidestepped the credit crisis – saw stock returns that lagged Europe. Brazil (FTSE Brazil) finished the year -21.02%, Russia (FTSE Russia) -20.74%, India (Sensex) -24.64% and China (Shanghai Composite) was -21.7%. However, the biggest loser of the year was Greece (FTSE Greece) which saw a return of -60.01% for 2011 (this was after a -45.83% return in 2010).
The continued debt crisis in Europe was the main reason for European stock declines (banks especially were clobbered) while BRIC losses can be attributed to the slowing global economy and a hard landing after years of rapid growth. The stock losses in Greece demonstrate what can happen when a sovereign mismanages its debt levels and capital flees when investors lose confidence in that country’s ability to effectively govern itself.
Commodities were down, overall – the Dow Jones UBS Commodity Index saw a return of -13.32% – although there were a few bright spots. Despite a late year selloff, gold continued its climb in 2011, ending the year at $1,566.80 per ounce, up 10.2% (this finish was well below its September peak of $1,895 per ounce). Crude oil was up 8.2% on the year, closing at 107.50 per barrel, while natural gas saw continued losses and finished the year -32%. Copper and cotton also saw big losses, finishing the year -22.73% and -36.69% respectively.
Once again, bonds performed exceptionally well in 2011. The Barclays US Aggregate Bond index saw a total return of 7.84% while the Barclays US Government index saw a 9.02% total return. Not to be outdone, the Barclays Municipal Bond index saw a total return of 10.7%. Even the Credit Suisse High Yield bond index (the riskiest of the bond space) saw a total return of 5.47% despite a big selloff in junk bonds during the third quarter.
While bond returns post-credit crisis have certainly been gaudy (virtually all client portfolios have some bond component), we can’t, as prudent investors, expect these rates of return to continue in perpetuity. Part of what has been driving these returns is the 0% interest rate policy the Federal Reserve enacted during the financial crisis. With rates this low, conservative investors who normally leave money in cash or buy CDs have been forced into the bond market in search of yield. Another factor contributing to these returns has been the continued lack of confidence in the global economy: when investors (both US and foreign alike) want to limit their risk exposure, they often look to the US bond market as a safe haven.
Eventually, though, interest rates will go up, the global economy will recover and investors will begin moving money out of bonds and into more risky investments. Our job is to try to make adjustments to client portfolios in anticipation of these market forces. So, with that in mind, we may recommend moving money out of the bond market towards the end of the year and into dividend paying stocks, inflation protected bonds and other non-correlated investments.
We look forward to speaking with you during our quarterly review and wish you the best over the coming year.
Regards,
Subir Grewal Louis Berger