BCN ADVANTAGE: 2012 ANNUAL REPORT
For 2012, the DJIA closed at 13,104, up 7.3%, the Nasdaq at 3,019, up 15.9% and the S&P 500 at 1,426, up 13.4%. Financials were the strongest industry sector, gaining more than 26%. Of the ten S&P 500 sectors, only utilities ended the year lower, falling 2.9%. Markets tend to do things that confound the greatest number of people. Since 2009, this meant snubbing fretful investors who have persistently bet on a market decline. Individual investors have poured nearly $210 billion into bond funds since the beginning of 2008, while yanking almost $700 billion out of U.S. stocks. In 2012 alone, investors added more than $90 billion to bonds, while pulling more than $150 billion from stocks. Over the last four years, stock investors have endured record daily price swings and three corrections of 10% or more (14 corrections of 5% or more). Daily price swings in the S&P 500 averaged 1.74% in 2008, the most for any year since the Great Depression. Price swings averaged 1.58% in 2009, the third most volatile on record. 2011’s 1.24% average was the seventh most volatile. Average daily price swings fell to 0.59% in 2012. If Congress and the President fail to reach agreement on real fiscal reform, if they raise the debt ceiling while continuing $1 trillion annual deficits, all three major credit rating agencies (S&P, Moody’s, Fitch) may downgrade U.S. debt – and precipitate a credit crisis. A downgrade by all three would compel major bond buyers (such as pensions) to either sell U.S. treasuries or stop buying future treasury debt. $85 billion per month works out to almost exactly $1 trillion a year. A coincidence? In 2012, the Federal Reserve was already the primary buyer for over 70% of newly issued federal debt. If the U.S. continues to run deficits this massive, the Fed has no choice. There is simply not enough money on earth to continue to absorb our mountain of IOUs. The U.S. government will never technically default. But the U.S. can (and will) be perceived as a major credit risk if it plans to pay back its creditors with devalued currency. A spike to 5% in borrowing cost would increase interest payments on our $16 trillion national debt from $250 billion to $700 billion per year. A spike to 7% would increase interest payments to nearly $1 trillion per year, equal to 40% of annual U.S. federal tax receipts. With U.S. treasury yields still near historic lows, market participants are not yet considering and have not priced in the possibility of a significant spike in U.S. treasury rates – despite the consequences already seen in Europe. We are nearing the fourth anniversary of the March 2009 bear-market low, with an unmistakable correlation between “quantitative easing” and the stock-market rally. The Fed quietly began its bond-buying program in late 2008. Since the Fed doubled down in 2009, the S&P 500 has soared 120 percent. By historical standards, the current bull market at 3.8 years of age is exactly the average bull market duration of the past 80 years. Since 1929, the year following a presidential election has been the least profitable – markets have been positive only eight of 15 times, with an average return of 4.7%. And more recessions have started in the first year of a presidential term than in the remaining three years – combined. Fed intervention raises doubts about whether improvements in the economy are sustainable, or merely the result of artificial government support. Today, after $3 trillion in freshly printed dollars, the Fed has likely exhausted – prematurely – its most effective monetary policy to offset fiscal austerity. This does not bode well for 2013.
