The pioneering Danish physicist, Niels Bohr, once said “Prediction is very difficult, especially if it's about the future.” Heeding Bohr’s sage admonition – after all, he was a Nobel prize winner - we’d like to preface this commentary by stating that predictions are just that - inexact guesses at what the future will hold.
Before looking ahead to 2012, let’s first look back at the last 12 months. With macro and micro economic data continuing to battle it out, uncertainty and volatility have been the resounding themes for the year. Since January, the S&P 500 has bounced around, reaching a high of 1,363 on April 11th (+8% gain) only to set a low of 1,099 on Oct 11th (-19% loss). As of this writing, the S&P has returned to January levels and, assuming moderately positive economic news continues to win out, the index should post a modest gain for the year.
Europe’s debt crisis has cast a deep and often dark shadow over the markets and the gloom will further persist in 2012. Based upon a policy that seems to be one of “muddling through”, European regulators and, in particular, the ECB, Germany, and France are struggling to find a solution to a very complex problem. The crisis has had a lasting effect on the European economy as governments implement dramatic austerity measures and banks pull back credit to shore up their balance sheets. A Euro-zone recession now seems increasingly likely and may significantly impact world growth in 2012. This slowdown would also act as a cap on growth in the U.S. in the year ahead as we export a fifth of our goods to Europe. Also, the magnitude of Europe’s poor health, as well as the U.S.’s financial systems exposure to it, remains unclear despite efforts by regulators to reassure. While the Fed’s recent action of cutting dollar-borrowing costs for banks led to a one day market rally of 4% in the S&P 500, it is speculated the Fed’s hand was forced in order to prevent the collapse of a large European bank and is ultimately only a band-aid to a broader problem. With many economists now viewing Europe as being in the same place as the U.S. economy was at the end of 2008, it will be a slow undertaking to make significant strides and may take up to five years before resolution is achieved in any meaningful manner.
On this side of the pond, the U.S. has seen improvements in recent months after a difficult summer/fall and may end 2011 growing at its fastest clip in 18 months. The consumer has returned with a gusto and open wallets for the beginning of the holiday season. On Black Friday, it is estimated $52.4 billion was spent during the four-day weekend, up 16% from last year. Cyber Monday was strong as well reaching a record $1.25 billion in sales, a 20% gain over last year. At its lowest since March 2009, the unemployment rate also dropped last month below the stubborn level of 9.0% to 8.6%. While part of this decrease can be attributed to some individuals giving up their search, an improving trend in the rate will benefit the overall economy. Payroll employment growth has accelerated as well from early summer, and initial claims for jobless benefits are dropping. Although still challenged, the housing market has also showed signs of improvement with the NAHB/Wells Fargo builder confidence index increasing to it highest since March 2010 and reflecting increased sales expectations in next six months. Further, the delinquency rate on residential mortgages declined to 8% in the third quarter, the lowest reading since the fourth quarter of 2008.
So what does this mean for 2012? While we share Bohr’s cynicism and believe that “expert” prognostications are often better predictors of what won’t happen, it’s hard to argue with the consensus that U.S. GDP growth remain at a positive - but slow - pace of 1.5% to 2.5% in the year ahead. Many of the large overhangs (such as the poor housing market, high unemployment, European debt problems, and slowing Chinese growth) will persist in 2012. Additionally, in an election year, Washington can’t be expected to take much dramatic action to boost the economy as politicians dig in their heels as evidenced by the recent shortcomings of the congressional debt reduction “super committee”. Alternatively, another U.S. recession is not likely as companies continue to experience strong demand for products abroad, see positive earnings growth, and are better positioned than in years past with large cash reserves and stronger balance sheets. Changes to these factors and/or exogenous events such as further instability in the Middle East will continue to fuel market volatility and could derail these expectations. Despite this, we remain cautiously optimistic for the year ahead, looking for a slow but improving general trend that will be often obscured by the ebbs and flows of the market.
1 – Index Components
Transportation: CH Robinson Worldwide Inc. (NasdaqGS:CHRW), Expeditors International of Washington Inc. (NasdaqGS:EXPD), FedEx Corporation (NYSE:FDX), Southwest Airlines Co. (NYSE:LUV), Union Pacific Corp. (NYSE:UNP), CSX Corp. (NYSE:CSX), Delta Air Lines Inc. (NYSE:DAL), United Parcel Service, Inc. (NYSE:UPS), and Norfolk Southern Corp.(NYSE:NSC).
Retail: 99 Cents Only Stores (NYSE:NDN), Dollar Tree Inc. (NasdaqGS:DLTR), Family Dollar Stores Inc. (NYSE:FDO), J.C. Penney Company, Inc. (NYSE:JCP), Kohl's Corp. (NYSE:KSS), Nordstrom Inc.(NYSE:JWN), Big Lots Inc. (NYSE:BIG), Target Corp. (NYSE:TGT), Sears Holdings Corporation (NasdaqGS:SHLD), and Macy's, Inc. (NYSE:M).
Healthcare: Amgen Inc. (NasdaqGS:AMGN), Eli Lilly & Co. (NYSE:LLY), Gilead Sciences Inc.(NasdaqGS:GILD), Johnson & Johnson (NYSE:JNJ), Abbott Laboratories (NYSE:ABT), Bristol-Myers Squibb Co. (NYSE:BMY), Merck & Co. Inc. (NYSE:MRK), Pfizer Inc. (NYSE:PFE), and Schering- Plough Corp. (NYSE:SGP).
Telecom: CenturyLink (NYSE:CTL), SBA Communications Corp. (NasdaqGS:SBAC), Verizon Communications Inc. (NYSE:VZ), AT&T, Inc. (NYSE:T), Sprint Nextel Corp. (NYSE:S), Windstream Corporation (NYSE:WIN), MetroPCS Communications Inc. (NYSE:PCS), and Crown Castle International Corp. (NYSE:CCI).
Financial Services: American Express Company (NYSE:AXP), Bank of America Corporation (NYSE:BAC), Berkshire Hathaway Inc. (NYSE:BRK.A), JP Morgan Chase & Co. (NYSE:JPM), The Bank of New York Mellon Corporation (NYSE:BK), Goldman Sachs Group Inc. (NYSE:GS), Morgan Stanley (NYSE:MS), US Bancorp (NYSE:USB), and Wells Fargo & Company (NYSE:WFC).
2 - Enterprise Value equals market capitalization plus net debt (long-term debt plus short term debt less cash and cash equivalents.
3 – TTM: Trailing Twelve Months
4 – EBITDA: Earnings before interest, taxes, depreciation and amortization
5 – BV: Book Value
6 –M&A comparables over the past trailing twelve months. Includes all transactions as reported by Capital IQ over the selected period and industry.