As we move toward the end of 2012, we are bound to hear talk about how it was a strong year for stocks. And at first glance, it is hard to argue with this fact given the double-digit year-to-date increase on the S&P 500. But in reality, focusing only on calendar year start and end dates to measure returns can be rather deceiving, particularly in the volatile markets over the last several years. For when standing back and viewing markets through a more comprehensive lens, we see that stocks over the last two years have provided far less to get excited about than recent headline returns might indicate. And without the vigor provided by monetary stimulus in the months ahead, stocks would otherwise be destined to thrash about in going nowhere except down.
Let's begin with an examination of stocks as measured by the S&P 500 (SPY). The S&P 500 first peaked at 1370 back in early May 2011. This was nearly 20 months ago. And following a sell-off later in 2011, it took a full ten months before the S&P 500 finally returned to this same peak at the end of February 2012. While stocks briefly managed to nudge through to new highs for two months in March and April 2012, they quickly went plunging again through the summer. It wasn't until August 2012 that stocks finally broke through to new highs, but they found themselves trading below the May 2011 peak as recently as mid November. So while stocks are indeed up nearly +14% on an S&P 500 price return basis for 2012 year-to-date, they are up just +5% over the last 20 months. And they were -2% lower from the May 2011 peak as recently as a month ago.
Why does this matter? After all, it could be argued that examining returns from a previous high in early May 2011 is just as arbitrary as focusing on the beginning of the calendar year as a starting point. It is important because for all of the likely discussion about how 2012 was a strong year for stocks, in reality they have struggled to break out to new highs over the last two years. And much of the gains in 2012 represented a recovery from the ground lost during much of the previous year after first reaching the May 2011 peak.
What is just as notable is precisely where the gains were derived along the way. In short, the stock market has been highly reliant on monetary stimulus to reach new highs. On December 21, 2011 when the European Central Bank (ECB) commenced its Long-Term Refinancing Operation, the S&P 500 Index was trading at 1243. Not only was this -9% below its May 2011 peak, but the only reason it wasn't even lower at that point was thanks to a coordinated central bank liquidity program that was initiated at the end of November 2011. And it was only following a 1 trillion euro ECB balance sheet expansion and two months later at the end of February 2012 before stocks finally found their way back to their May 2011 peak.
The momentum of the ECB's LTRO program carried stocks for another month to a new high at the very beginning of April 2012 at 1422 on the S&P 500. This was nearly nine months ago. And where have stocks traveled since then? Virtually nowhere. For as recently as last Friday before the fluffy rally to start the current week, stocks were trading lower from their early April 2012 peak.
In short, all of the gains in the stock market over the last 20 months can be encapsulated in one single event that occurred over roughly two months from late December 2011 to the end of February 2012. And this was when the ECB pumped 1 trillion euros, or roughly $1.3 trillion into the global financial system. Everything else along the way has been essentially trading noise.
Highlighting the otherwise lackluster performance of stocks over the last two years even further is the path that the other major markets have followed over this same time period.
U.S. small cap stocks as measured by the Russell 2000 Index (IWM) have traveled a two-year choppy road to nowhere. Small caps have already failed at what is now firm resistance at its early May 2011 peak four previous times. At present, it is making its fifth attempt at trying to breakout to new highs.
The results from non-U.S. markets are even less exciting.
Developed international stocks as measured by the MSCI EAFE Index have come nowhere close to revisiting their May 2011 peaks. At present, they remain stuck below a lower resistance level.
Emerging market stocks have endured a similar path, as they also remain well below their early May 2011 highs and are also mired below a lower resistance level.
What does all of this information mean going forward? Basically, we have reached a phase in the post crisis rally where stocks require full blown aggressive balance sheet expanding monetary stimulus from one or more of the major global central banks to move sustainably higher. Otherwise, they are bound to grind sideways and may eventually find themselves moving lower as other fiscal and monetary support measures expire. So the fact that the U.S. Federal Reserve is poised to inject another $1 trillion of monetary stimulus into the financial system in the coming year is significant, as it suggest that we may see stocks float higher over the coming months in what would otherwise be an inexplicable advance from an economic and corporate fundamentals standpoint. The rise may prove particularly profound if the ECB and the People's Bank of China join in with balance sheet expanding stimulus of their own along the way.
It is for this reason that I remain long stocks a part of a diversified investment strategy. This includes broad allocations to U.S. mid-cap stocks (MDY) and emerging markets (EEM). This also includes allocations to specific names that are likely to benefit most from monetary stimulus including Occidental Petroleum (OXY), BHP Billiton (BHP) and Potash Corporation (POT) as well as selected emerging markets including China (FXI) and Brazil (EWZ). And although both precious metals have suffered a notable decline in recent days, the outlook for both gold (GLD) and silver (SLV) is as strong as ever once the printing presses start running. The Central GoldTrust (GTU), Central Fund of Canada (CEF) and Sprott Physical Silver (PSLV) all provide ideal ways to establish this exposure for those who would rather establish this exposure in a portfolio instead of taking delivery of the physical metals.
Of course, the higher stocks climb on monetary stimulus, the harder they are likely to eventually fall once the money printing party ends. And barring a miraculous turn of events for the global economy in the next 12 to 18 months, global stocks may ultimately suffer a most unpleasant return to the ground. Thus, monitoring the global central banks in the coming months will be as important as ever, for stocks will likely be left with nothing else once the stimulus is finally over.
This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.