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Investment Results for 2012

By: Beese Fulmer
Tuesday, January 15, 2013

Investment Results for 2012

As you can see from our tables and charts, 2012 was a good one for the major stock benchmark averages. It is interesting to note that for two of the three, it seems the high water mark was hit at the end of the first quarter! You didn’t even have to wait until May to go away! The S&P 500 Index did add to its first-quarter gains though and finished the year with a 16% total return—quite a turnaround from its 2% advance in 2011. Something worth noting: In 2012, six of the ten S&P sectors underperformed the Index. At year-end, the ten largest companies in the Index equaled 19.6% of its total weighting. The largest company in the S&P 500, Apple, with a 3.94% weighting, held the top spot despite its price decline late in the year. The other nine stocks in the top ten were (in order of cap-weight): Exxon Mobil, General Electric, Chevron, IBM, Microsoft, Johnson & Johnson, AT&T, Google, and Procter & Gamble.

We’ve listed the sector weighting and performance of 10 industry groups that make up the S&P 500. The Financials sector enjoyed the best gains for the year, as a few of the large, “given up for dead” banks posted huge gains. Very surprising to us, given the low interest-rate environment in force last year, was the woeful performance of the Utilities and Energy sectors, both of which include stocks with above-average dividends. It’s hard to estimate the amount of selling that took place in these sectors in anticipation of much higher taxes on dividends and capital gains, but it was surely considerable. For whatever reason, as the Bespoke Investment Group chart on the last page shows, dividend payers underperformed more “growthy” names by a wide margin.

As we’ve noted many times over the last three years, Mr. Bernanke’s Fed has encouraged (forced?) investors into stocks and out of fixed-income investments by keeping interest rates compressed. It is a natural reaction for those investors to choose stocks with higher yields than the overall stock market offers (which is less than 2%). But in 2012, which turned out to be a “risk-on” year for equities despite a cautionary economic backdrop, the more conservative you were, the smaller your return. Let’s repeat that: In 2012, the more risk-averse an income-starved saver was in selecting his dividend-paying stocks, the smaller the return. It’s a cruel irony for safety-seeking investors who have been manhandled by the Fed’s market manipulation.  We nominate the Bespoke chart as the most insightful of 2012.

The 30-stock Dow Jones Industrials--which offered investors a return nearly four times that of the S&P 500’s in 2011--underperformed the S&P by nearly 6% in 2012, with a total return of 10.23% for the year. And the Dow finished 2012 at a price level lower than it posted at the end of March. On a price-return basis, four stocks lost money for investors--Intel (-14.9%); McDonald’s (-12.1%); DuPont (-1.8%), and Caterpillar (-1.1%), while 14 stocks underperformed the benchmark (again, on a price-return basis). The best price-return performers in the Dow in 2012 were Bank of America (+108.6%), Home Depot (+47.1%), Disney (+32.8%), and JPMorgan (+32.2%).

The NASDAQ Composite, home of tech giants Apple, Google, Microsoft, Cisco, Oracle, and Intel, advanced by 15.9%, which was quite different from its 2011 loss of nearly 2%. Despite its late-year swoon, Apple managed a gain of 31% last year, while Amazon, sort of a tech wannabe, gained over 40%. The NASDAQ is another benchmark that finished the year at a price level lower than it enjoyed at the end of March.

On the fixed-income side of the ledger, the Fed’s policy of financial repression continued unabated. Earning next to nothing on savings not meant to be allocated to equities is a forced austerity program on baby boomers—an austerity program NOT being forced on the public sector. The 10-year Treasury Note began the year with a yield of 1.88%, dropped to yield just 1.38% in July, and ended the year at 1.76%. Seems like a ho-hum year for investors in the 10-year Treasury, unless you bought at the 1.38% level, because that investor took a hit to the market value of his investment.

Some Things Never Change

While young folks were watching the ball drop in Times Square, many investors were glued to the tube waiting for the hammer to drop on their incomes. CNSNews.com reports that, true to form, “the U.S. Senate voted 89-8 to approve legislation to avoid the fiscal cliff despite having only 3 minutes to read the 154-page bill and budget score… It seems the senators received the bill at approximately 1:36 AM on Jan. 1, 2013 – a mere three minutes before they voted to approve it at 1:39 AM.” One member of Congress described his peers in a fitting manner, calling this group of do-nothings the “Congress of Chronic Chaos.” What a farce! Congress loves these last-minute deals—it’s so much harder for anyone to notice the pork in a bill when you haven’t taken the Evelyn Wood speed reading course. And it’s especially fitting that a bill that was supposed to deal with our overhanging long-term deficit problem has been determined by the non-partisan Congressional Budget Office to add $4 TRILLION in debt over the next decade—which means we will hit the $20 trillion mark by the time the president hands over the job to Hillary.

John McCain took the floor of the Senate on January 3 and pointed out some of the “important” elements that were included in a bill meant to “reduce” our nation’s debt load: $430 million in tax breaks for Hollywood film and TV producers; $70 million in tax incentives for NASCAR track builders; $59 million in tax credits for algae growers; $15 million in subsidies for asparagus growers; and, of course, $7 million for buyers of two- or three-wheel electric scooters. In fact, it appears that the fellow in the White House extended $67 billion in annual tax credits to companies and groups he supports (that’s money the government doesn’t get) versus the $62 billion a year the government will collect from the increased taxes on the rich! The extra tax dollars won’t decrease the deficit because they’ve already been given away! You can’t make this stuff up!

Here is a concise summary of the truly important sections of "The American Tax Relief Act" that came out of Washington’s sausage-making machine:

  • Increase in top tax rate - The top tax rate will increase from 35% to 39.6% for individuals with taxable income over $400,000 ($450,000 for joint taxpayers).
  • Permanent "AMT Patch" - The Alternative Minimum Tax exemption amount is now permanently indexed for inflation for 2012 and future years, allowing more than 25 million taxpayers to avoid having to pay AMT.
  • Increase in tax rate for Capital Gains and Dividends - The tax rate for long-term capital gains and qualified dividends is increased to 20% (from 15% for 2012), for individuals with taxable income over $400,000 ($450,000 for joint taxpayers). Also, don't forget, investment income is subject to a Medicare surtax of 3.8% for individuals with income above $200,000 ($250,000 for joint taxpayers), resulting in a total tax rate of 23.8% for the "high income" taxpayers.
  • Personal exemption and itemized deduction phaseouts - Taxpayers with adjusted gross income ("AGI") above $250,000 ($300,000 for joint taxpayers) will no longer receive dollar for dollar deductions for personal exemptions and itemized deductions. Itemized deductions are reduced by 3% of AGI above the threshold to a maximum of 80% phaseout and personal exemptions are reduced by 2% of AGI above the threshold.
  • Social Security 2% reduction - The 2% reduction in employee Social Security tax was allowed to expire and was not extended to 2013. Therefore, employees will pay 6.2% for Social Security taxes on earnings up to the cap of $113,700***
  • Estate, gift and generation-skipping transfer tax - After 2012, the exemption amount for estates and gifts is $5 million (adjusted for inflation) and the tax rate is increased to 40% (from 35%).
  • Research tax credit - The credit for research and development expenses has been extended through 2013.
  • Individual credits - The Child Tax Credit, Earned Income Credit, and American Opportunity Credit (college tuition) have been extended for five years.Some of the non-tax aspects of the bill included the following:
  • Unemployment benefits - Benefits have been extended for one year for the long-term unemployed.
  • Medicare "Doc fix" - The physician reimbursement reductions of 27% from Medicare which were set to go into effect January 1st, have been delayed.

*** By the way, Nick Colas, of ConvergEx Group, makes some smart observations about the 2% increase in the payroll tax. About 79% of U.S. households make less than $100,000. After subtracting out those that are in retirement, not in the workforce, or earn less than $25,000, he figures there are still more than 50 million families “or related groupings living under one roof” that will be impacted by this increase. If you assume an average income of $50,000, that is $1,000 per year in additional taxes. Middle-class families will be hit hardest by this change, and Nick bets it will affect decision making about “eating out, family vacations, and extra school supplies or trips.” Indeed, the president continues to claim this new bill results in tax savings for the “middle class,” but, in reality, it’s a tax increase for these folks that will impact them far more than will higher tax rates for the ultra-rich. It will be interesting to see how readings of consumer confidence evolve over the next 12 months.

The Election

After obsessing about the fate of the Eurozone for most of the year, the fourth quarter’s market action revolved around concerns about the election and, after that, the negotiations about the Fiscal Cliff. As a result, all three of our stock benchmarks declined during the fourth quarter. What can we say about the election results? President Obama received nearly 5.5 million fewer votes than he did in 2008 and he still won! And, though it appeared for several weeks that the Romney team garnered fewer votes than the McCain/Palin ticket in 2008, the “final” tally shows Romney/Ryan bested the previous ticket by about 30,000 votes. Still, the turnout total is very surprising to us. According to a report we’ve seen, it seems that President Obama’s “response” to Governor Christie’s plea for help after Hurricane Sandy played a bigger role in the election for last-minute decision makers than did the president’s horrible first debate performance or Vice President Biden’s impersonation of a mentally deranged politician in his. And now we learn from one of Mitt’s sons that “his father’s heart was never really in it” to be president! He was running for almost six years for cripes’ sake! Looking at the economic news only, the president should have lost this election, but he didn’t, so we have to move on, and as the Eagles song reminds us, “Get over it.” Looking at the electoral map, the folks who voted for the Obama/Biden team are much more likely to be paying the highest income tax rates going forward than are the rest of us. A bit of payback, perhaps, but it is not much to cheer about when you consider the big picture.

The Year Ahead

After four straight years of gains for the S&P 500, we’re taking a cautious approach as we begin 2013, although Wall Street analysts are almost uniformly bullish in their outlooks for this year—and the first day of trading was certainly something for the bulls to cheer about. Perhaps this is the year we’ll get Mr. Bernanke’s coveted stock market “melt up” as everyone buys stocks in order to earn something on their savings. The Fed’s easy-money policy has definitely pumped up asset returns since March 2009, even though individual investors spent 2012 mostly selling U.S. stock funds and buying bond funds (again). It will be interesting to see how the economy (and the investing public) respond as the Fed retracts its money printing activity. And it might come sooner than expected; on January 3 it was reported that some members of the Fed believe the quantitative easing program should end earlier than Mr. Bernanke’s stated 2015 target date. In his mid-December speech, Mr. Bernanke tied the end of his money printing to an unemployment rate of 6.5%--but the release of the minutes from the meeting that preceded his speech show it’s apparent some Fed members are worried about the negative effects on asset prices if the Fed continues printing dollars. Don’t be surprised if investors are forced to watch the direction of interest rates more closely this year. Rising interest rates in response to an improving economy won’t be an impediment to further stock gains, but if short rates get to 4%, savers will have an investment alternative they haven’t had for years.

Over the next few months, it’s likely that more high drama will return to Washington as the political parties debate the debt-ceiling limit. Volatility could result. Moving forward, the unknown for the market is how companies and consumers react to the mountain of new regulations and taxes coming their way—and as ObamaCare ramps up. And we can’t forget all of those pesky international issues that pop up every few months. It will be an interesting year! (Written 1/4/13)

We hope you enjoy this issue of our Investment Outlook. If you know of anyone whom you think might benefit from our investment management services, we would be pleased to add them to our Outlook mailing list as a way of introduction. Client referrals are our most valuable source of new business; they are especially gratifying because they mean you are pleased with the job we are doing for you.

Sources for this Outlook include, but are not limited to:

 Barclays Research, Bespoke Investment Group, Tax summary is courtesy of Bruner-Cox LLP., CNSNews.com, ConvergEx Group, Investor’s Business Daily, Morgan Stanley & Co., NASDAQ, Standard & Poor’s, and The Wall Street Journal.

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