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2012 Market Review

Jan 16, 2013 Marc Odo

Much of the data used in this write-up was sourced from one of our capital market overview templates. We have a self-writing version available for download that looks at the raw data and, using If/Then code, is able to write out a general summary of the markets.  It’s pretty cool and is available here.

I think the most surprising thing about 2012 was just how good of a year it was for the markets. It seemed all the headlines were negative last year- lingering Euro crisis, faltering Arab Spring, a very bitter U.S. election, Hurricane Sandy, the fiscal cliff- and yet the broad U.S. market posted a 16.4% gain, as measured by the Russell 3000. There were only three down months in the Russell 3000 in 2012, the bad one being May when it looked like Greece would get kicked out of the Euro and the whole currency union might come unraveled. The Russell 3000 lost 6.2% in May, but other than that it was a fairly strong year.

The broad theme seen in the data is that the more risk you took, the more you were rewarded in 2012. U.S. stocks did better than U.S. bonds (16.4% vs. 4.2%). International stocks did better than U.S. stocks (17.9% vs. 16.4%). Emerging markets (18.6%) did better than international stocks (17.9%). Risky sectors/industries generally did better than conservative sectors/industries. Corporate bonds did much better than government bonds.  High yield did better than investment grade. With few exceptions, it was a “risk on” kind of year.

Value eked out a win versus growth in the last month of the year. The Russell 3000 Value ended the year up 17.6% versus a 15.2% gain in the Russell 3000 Growth, but through November both were up an identical 15.0%. 2012 was the first year value has outperformed growth since 2008. For the third year in a row, the distinction between value and growth has been less than 2.5%.

What didn’t work? Back in 2011 everyone was talking about investing in dividend producing stocks. This made sense, as yields on bonds were so low it paid to look elsewhere. In 2011 the S&P Select Dividend Index gained 12.4% vs. 1.0% in the Russell 3000. However, by 2012 that strategy had run its course and dividend strategies trailed the broad market. In 2012 those same indices gained 10.6% and 16.4%, respectively. Most of the dividend-focused ETFs trailed the broad market as well. A 10.6% return is still a strong gain, but illustrates the dangers of chasing last year’s trend.

Instead yield-chasers went after corporate and high yield bonds. The Citigroup USBIG Corporate index trounced the Citigroup USBIG Treasury Index, 10.0% vs. 2.0%. Keep in mind that 10.0% is for investment-grade corporates, not junk debt. The BoA/Merrill Lynch High Yield indices show the same high risk/high return spectrum with the junkiest stuff doing the best. The BoA/Merrill Lynch BB Index had a 14.4% return and the BoA/Merrill Lynch CCC & Lower index had a scorching 20.3% return. Real estate has also continued its run, as the FTSE NAREIT was up another 20.1%, the third time it posted a +20% gain in the last four years.

Unfortunately, if you didn’t participate in 2012’s run in corporates and high yield, you probably missed the boat. Spreads are thin now, with much less upside to gain and more downside to be had. If you are a contrarian and if you believe that everything eventually reverts back to its mean, commodities might be attractive. Overall commodities had a poor year and were the one major exception to the high-risk/high-reward theme. The Dow Jones UBS index lost 1.1% in 2012. Within the broad market of commodities, however, there was a wide dispersion of results. Energy and Petroleum did poorly, as Libya and Iraq sort out their industries and the U.S. is in the midst of a boom in production via these new extraction technologies. Grains did especially well as droughts and poor harvests worldwide hit supplies.

With this last section, I’m going to dig a little deeper. The Citigroup USBIG Treasury Index had a return of 2.0% in 2012. Given that low-risk investments had low 2012 returns, this is no surprise. But if you break it down by months, all of 2012’s gains came in April and May. Again, this was when it looked like Greece would get kicked out of the Euro and we’d see the domino effect throughout Europe and the rest of the world, so there was a brief “flight to quality”. But without those two months Treasuries would have lost money in 2012. In fact, the Treasury index had negative returns in seven of 2012’s twelve months.  This shouldn’t be a surprise, as yields have been infinitesimal for the last couple years and yet investors have been piling in to bonds. Sooner or later, that dam is going break.  Are these the first cracks?

As Warren Buffet once said, “You have to be afraid when everyone else is greedy and greedy when everyone else is afraid.”  Here’s to 2013. 

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