The last time I discussed the “technical” landscape of the stock market, the market was in a very difficult place. The market had just experienced a 22% correction in 5 months, and the market was in a period of great uncertainty. We asserted that for the bull market (upward) to return, we should see a “Santa Claus” rally, a period of less volatility, and the market reclaim 12,000 on the DOW. Each of these events has occurred, and this rally has exceeded what many envisioned back in the fall of 2011. So, we ask ourselves: Where does this leave us? Are we in a new bull market? Is this decade going to be better than the last? What can we expect for the remaining months in 2012? Let’s outline the technical picture for this year, and build on other aspects of a bull market later this year, assuming we continue on an upward path. It is not yet the time to offer a forecast covering the next few years, but we can present you with the central themes we are following for 2012. These are in no particular order, and are based on our observations from the past 10 years of directing assets in a difficult market.
1. During the past 10 years the market has had a correction in January/February every year. We expect some form of correction later this month and to last on into early March. If the market does not go through a correction, this would be a trend break and very bullish. For this to be a bull market, the correction (assuming we have one) should be mild in nature. For the market to remain in an upward trend for 2012, the 200 day moving average on the DOW Jones Industrial average should hold the remainder of the year; it is currently around 12,000 on the DOW Jones Average.
2. Volatility is a sign of market weakness. Three of the past four years we have seen extreme volatility in our markets. When the DOW has more than a few days of plus or minus 2%, it can be a sign of a weak market. Over the past 4 months, volatility has died down, and as long as we continue with lower volatility, the markets should be healthy for 2012. If volatility returns in 2012, we will then discuss what that means for investors. Bull markets are markets with prolonged periods of limited volatility. January was a very healthy start!
3. Interest rates will remain low for this year. The Federal Reserve board announced in January that they plan to keep rates low through 2014. Some argue that if the economy was improving, the Fed would raise rates sooner, rather than later. There are too many risks in the economy for the Federal Reserve to raise rates now, such as the housing market which is still struggling. Keeping rates low is bullish for short term bond funds (5 year duration or less). IAP uses five bond funds in client portfolios, and their returns ranged from 2.5% to 9% last year. We expect the yields on bond funds to perform in the 2 to 6% range this year. We do not expect a negative year for bonds.
4. The US economy vs. the World economy (OUR KEY ISSUE). Currently the US economy is showing overall signs of improvement; the world economy is not. The US stock market is pricing in a US economic recovery and ignoring the world economic situation. If this trend continues and the world economy is managed successfully, then it is possible to see the Dow approach 14,000 this year. The past 3 years we have had some rough patches in April-September, and it appears that this period could be rough for our markets again. It is an election year, and in some cases the market has not performed very well going into the election. If volatility remains mild and the world economic leaders (including our own FED) keep rates low along with policies that are pro-liquidity, then we should have a decent 2012. If the DOW maintains 12,000 on any correction and starts to climb above 13,000 in the spring to early summer, then we should see an attempt a charge to 14,000 after the election. If the market gets below 12,000, then we could be in for a poor 2012. We will discuss that situation if it occurs, but most likely it would mean that the world economic situation is having troubles. Currently there are no forecasters on Wall Street that expect the market to get back below 12,000. We believe this is a key number for the market to hold in 2012.
5. The Election of 2012: I am a believer that the trend of the US stock market determines who is elected as the President of the United States. If you research how markets were faring the year of an election, it is a pretty good indicator of whether or not the incumbent stays in the White House for another 4 years or if there is a changing of the guard. Both political parties are aware of this trend. So, politics aside, if the market holds 12,000 this year, and is 13,000 around the election time, the incumbent will remain in office. If, however, the market is trending down, the President’s approval rating will trend down, and the Republican nominee will win the election. Let’s see if the stock market can again forecast the election for this year like it did in 2008, 2004, 2000…