Wednesday, January 11, 2012

In an election year, stick to your plan!

The prevailing thought from investors going into 2012 seems to remain at extreme caution.  It is an election year after all, Europe remains in a financial crisis, and unemployment is still very high.  The assumption for this year’s investment strategy based off the aforementioned should be to remain “safe” with cash and bonds, right? Not necessarily.

When you first sat down with your advisor to develop an investment plan to reach your goals, making massive changes to your portfolio every year based on what the current economic conditions were was probably not part of the plan you implemented.  Your plan was based on
long term projections vs future income needs. There are many studies that show the more changes you make to your portfolio, the lower your rate of return will be. My favorite study that proves this theory is the Dalbar yearly study on investor behavior (google “Dalbar yearly study” or “QAIB” for the entire report).

Most believe that my job is predicting what the market is going to do and how it is going to react to certain events.  This is not the case, as I am not an economist or fortune teller for that matter.  With that said, I feel the most important part of my job is getting clients to look past the pessimistic media or recent current event and look at historical based studies and positive market indicators to help them make informed decisions to determine what their final retirement “number” needs to be.  In most cases, this means following the plan we created in the first place and reviewing this plan each year. Sure, over the course of time there are certain events in which an investment plan needs to be reconsidered, but it isn’t something that changes yearly and it definitely isn’t to time the market with current events, elections, natural disasters, and so on.

With these thoughts in mind and because I enjoy being optimistic that recovery is in our future, our Chief Market Strategist Jeffrey Kleintop is predicting a positive market this year, somewhere in the range of 8%-12%, with an outside chance for returns significantly higher than that. 

From his recent weekly market commentary:

Does the pattern of performance exhibited by stocks in 2011 bode ill for 2012?  Not historically, as the last time we saw a year with similar performance was 1994. Similar to 2011, in 1994:
                        The S&P 500 was basically unchanged for the year with a total return of 1.32%
Earnings for S&P 500 companies grew at a double-digit rate Defensive sectors, such as Consumer Staples and Health Care outperformed.

While things may have looked bleak in 1994, it turned out to be far from the end of the business cycle. In fact, 1994 turned out to be the set up for the strongest five-year run in history for stocks as valuations soared, starting with a 38% total return in 1995. Recall that as of the end of 1994, the price-to-earnings ratio measured on the past four quarters of earnings, had fallen below average and was setting up for a surge in valuations in the years ahead.

Moreover, valuations, as measured by the forward price-to-earnings ratio on the consensus forecast for the next four quarters of earnings, had dropped to 12.4 as of the end of 1994. This is a similar level to today’s 11.7.

Looking back further, we can see that in total there have been four years since WWII when the total return for the S&P 500 was basically flat: 1953, 1960, 1994, and 2011. All three of these years that preceded 2011 were followed by strong gains in the following year, averaging 38%.

While the historical pattern suggests that a strong 2012 may follow a flat 2011, our outlook remains for an average gain for the S&P 500 of about 8 – 12% in 2011, as detailed in our 2012 Outlook publication. We see these gains supported by a slight improvement in valuations and mid-to-high single-digit earnings growth as the pessimistic outlook for profits reflected in the markets rise to converge with a slide in the lofty expectations for earnings projected by Wall Street analysts.