First Quarter, 2012 Economic and Market Commentary

In a twist of irony, the first quarter of 2012 simultaneously saw the long anticipated Greek default and the best quarter for U.S. equities in nearly 14 years. Although the Greek event was characterized as a "bond swap" the net effect was that Greek bond investors took a substantial write-off on their investment. From a global equity market perspective, however, it was the combination of the orderly nature of this debt restructuring, additional cash infusions by the European Central Bank, and austerity measures approved by the Greek parliament that investors cheered. Add to this a continued downward trend in the jobless rate (to 8.2% as of March 31st), a housing market finally showing signs of life, positive results from the latest round of "stress tests" on U.S. banks, and a relatively silent Capitol Hill, and you had the ingredients for healthy equity market returns.

While we were glad to see the equity markets continue their gradual recovery from the doldrums of the financial crisis, there are still a host of concerns potentially weighing on equity markets. First, and probably most notable, is that the European sovereign crisis is far from in our rear view mirror. Most economists are in agreement that the Eurozone, with a jobless rate of 10.8%, is heading towards or already in recession. With central banks having already provided significant liquidity to Greece and other peripheral Eurozone members, the amount of future support they can provide has likely diminished significantly. Thus, Eurozone recovery could be a prolonged process. While we would not expect a Eurozone recession to materially impact the U.S. economy, as only a small percentage of U.S. GDP is dependent on exports to Europe, certainly this could advesely affect sentiment on Wall Street in the short term, especially if corporate earnings in the U.S. lose any of their recent steam.

Second, rising oil and gasoline prices are once again confronting consumers. This not only impacts consumers at the pump, but also in the cost of countless other goods and services here and around the world. We do not believe current oil or gas prices, even at their elevated levels, will independently lead to a major spike in inflation or derail consumer spending. However, if these prices were to continue to rise, it is likely that future GDP growth will be impacted.

Lastly, there continues to be indicators that China, the world's fastest growing country for the last several years, is beginning to slow down. China's GDP growth slowed to 8.9% in the last quarter of 2011. While most countries would be ecstatic with this level of growth, China's GDP has averaged 10% growth a year over the past 30 years. China's growth creates demand for commodities for many developing countries and for industrial products and services for many developed countries so a prolonged and/or precipitous growth rate decline could have global ramifications.

But these are just a few examples of the many extenuating factors that cause investors to be either more optimistic of pessimistic about the future earnings and the direction of equity markets. We would suggest that many of these factors are largely priced in to equity pricesat most points in time. This is not to imply the market will not be volatile as the multitude of these factors is digested by the markets. It does imply that time is a critical component of our investment policy. We therefore continue to advocate an investment policy that only allocates to growth those funds that have been proven, with reasonable confidence, not to be necessary for several years.

History has shown that investors who adopt this approach have been rewarded over most long-term holding periods. Going back to 1950, stocks have an annual average total return of 10.8% compared to 6.3% for bonds. Further, annualized ten and twenty year relative returns of equities versus bonds have been at their most negative for more than a century, suggesting equities may be the better performing asset class during the next several years as the equity risk premium normalizes. Of course, no one can predict teh future and historical results are not necessarily indicative of future results. However, our investment policy should increase the probability of achieving a premium return at a reasonable level of risk.

The following table reports the returns over the three and twelve month periods ending March 31, 2012 for the indices that we use to benchmark growth component returns:

Benchmark Sector


3 Month Return

12 Month Return

Large-capitalization Domestic

S&P 500



Mid-capitalization Domestic

S&P 400



Small-capitalization Domestic

Russell 2000



Micro-capitalization Domestic

MSC US Microcap



Developed International Markets




Emerging International Markets




Real Estate Investment Trust




Global Real Estate Investment Trust




While the quarter began with 10-year U.S. Treasury Notes selling for their lowest-ever yield (an indicator of risk aversion), it ended with the Dow advancing for the sixth straight month and the NASDAQ closing above 3,000 for the first time since 2000. Once again equity returns were strong across all asset classes utilized in the model growth component. All asset classes saw double-digit returns with microcap, international real estate, and emerging markets providing the highest relative returns. From a sector perspective, financials, a laggard the last couple of years, had a bounce back quarter and was the best performing sector with a 22.0% return.