In this article we shall explore two questions:
1. How good was the absolute and relative performance of stocks in 2012?
2. Who got it right?
How Good Was 2012?
1. In 2012, the total return of the S&P 500 (including dividends) was 15.83%. Capital appreciation contributed 13.41% while dividends contributed 2.42%.
2. On a total annual return basis, 2012 ranks as the 40th best performance out 85 years since 1928 (the official start date of the S&P index). This places the 2012 annual performance in the 53% percentile rank.
3. Compared to the total return on 10Y Treasury Bonds the total return of the S&P 500 in 2012 ranks 36th out of 85 years since 1928. This equates to a 58% percentile rank.
4. Compared to the total return on T-Bonds, the total return of the S&P 500 in 2012 ranks 33rd out of 85 years since 1928. This equates to a 61% percentile rank.
5. The average (geometric mean) total return of the S&P 500 since 1928 has been 9.31%.
So, without taking into consideration any assessment of the level of risk assumed to achieve these equity market returns in 2012, what can we conclude regarding the absolute and relative performance of the S&P 500 in 2012?
1. In absolute terms, 2012 was "middle of the pack" (40th out of 85) in terms of good/bad years.
2. In terms of relative performance compared to 10Y Treasury Bonds or T-Bills, 2012 was "middle of the pack" (36th out of 85 and 33rd out of 85, respectively) in the 85 years since 1928.
3. The 15.83% total return in 2012 is significantly better than the average (geometric mean) return since 1928 of 9.31%.
4. Readers should note the apparent disparity between the first two points and the third point above. Total returns in years that rank "middle of the road" are actually quite good relative to the long-term average. However, this can be deceiving - particularly to those who employ passive asset allocation strategies that maintain a constant allocation to equities. The reason for this apparent disparity is that the damage done to long-term returns by the worst years (bottom 20th percentile) significantly outweighs the benefits achieved during the best years (top 20th percentile). This highlights the importance of avoiding the "bad" years - even if it is at the cost of missing out on some "good" or "average" years.
In sum, 2012 ranks as a "middle of the road" year for stocks. Whether having assumed the risks necessary to obtain such results was wise and/or worthwhile from a risk/reward perspective is a matter that will not be addressed in this article.
Who Got It Right?
In terms of absolute and relative stock market performance, it is clear that relatively few professional fund managers "got it right" in 2012. According to widely published data, about 65% of stock mutual fund managers underperformed the S&P 500 in 2012 while almost 90% of hedge funds (generally considered the "smart money") underperformed the index in that year.
So who got it right? Well, there are several fund managers, strategists and financial commentators that are currently busy taking "victory laps" in January of 2013. But are the accolades they seek actually deserved? Let's take a close look at the major arguments of those who were bullish on stocks at the beginning of 2012.
1. The problems in Europe are overblown; the economy in Europe will perform better than expected. Wrong. The economy in virtually every European country (and particularly the PIIGS) performed worse than the consensus of published estimates in January 2012. Indeed European economies as a whole performed worse than most of the more pessimistic estimates preferred by economists and strategists at the time. Thus, managers who invested on this basis did not "get it right." They got it wrong.
2. Europe is irrelevant to the US and the US Economy will perform well and/or better than expected. Wrong. First, in 2012 the US economy grew at historically low rates compared to previous economic expansions, while it generally performed in-line to worse than consensus expectations as of January of 2012. Second, noticeable accelerations and decelerations of US economic growth directly coincided with the ebb and flow of conditions in European economies and financial markets. Therefore, managers who invested on the basis that Europe did not matter and that the US would do swell did not get it right; they got it wrong. The European crisis did impact the US economy and this is largely why US economic growth was meager and disappointing.
3. US corporate earnings growth will be strong and exceed expectations. Wrong. US corporate earnings growth was barely in the low single digits for 2012. This earnings performance was dramatically below historical long-term averages and was also well below consensus expectations at the beginning of 2012 that generally assumed high single digit growth. Furthermore, the meager earnings growth in 2012 was of questionable quality - earnings growth for the S&P 500 would have been negative if it had not been for Apple's (AAPL) exceptional (and unsustainable) performance as well as the one-off gains of a few large banks such as Citibank (C) and Bank of America (BAC) whose EPS numbers were boosted by questionable reversals of loan loss reserves. Thus, those who recommended stocks on the basis of strong corporate earnings did not get it right; they got it quite wrong.
4. US Stocks are cheap. Wrong. As I have explained previously, at no point in 2012 were US stocks notably cheap on either a forward 12-month or a trailing 12-month PE basis. To the contrary, stocks were generally on the higher end of the historical average range for these metrics. Furthermore, contrary to popular belief, low interest rates do not necessarily make stocks attractive from a historical/empirical or even a theoretical point of view. Analysts who argued that stocks would rise in 2012 because they were cheap simply do not understand the historical data or the relevant theory on the matter. These analysts simply got it wrong.
5. Investors will "switch" en masse from bonds to stocks. Wrong. Investors continued to pile into bond funds in record numbers while fixed income yields and spreads across the board fell. At the same time, stock funds continued to lose assets, while overall equity trading volumes were at multi-year lows. Thus, the pundits who predicted "the switch" did not get it right; they got it very wrong.
6. Expansionary central bank policies will trigger "reflation" which will favor stocks. Wrong. There was no "reflation" in 2012. The rate of inflation actually decelerated in the US and the rest of the world in 2012. Furthermore the prices of key commodities usually thought of as lead indicators of inflation, as represented by the CRB index, were down for the year. Thus, those pundits who predicted "reflation" did not get it right; they got it utterly wrong. A final note: The very premise of this prediction is unsound. First, if the argument were premised on high inflation, then such conditions in the US have been historically associated with PE contraction and sub-par returns for stocks. Second, if the argument from those proposing the "reflation" thesis were based on a premise of hyper-inflation (as opposed to merely high inflation) then their prediction was even more spectacularly wrong. Either way, the "reflation" thesis was both unsound and wrong.
7. Central bank "money printing" will cause money to flow into stocks. Wrong. First, see points #4 and #5 above. Second, money supply growth, as defined by the growth of standard monetary aggregates such as M1, M2, M3 and MZM never actually took off. Across the board, money supply growth in 2012 was well within historical ranges. Third, there is no evidence of excess liquidity having driven equity markets. Quite to the contrary, equity trading volumes in 2012 were extremely low. Thus, those analysts who predicted that masses of newly minted money would flow into stocks did not get it right; they got it badly wrong.
In sum, beware of the fund managers, strategists and/or financial commentators who are taking "victory laps" and saying "I told you so." It is instructive to go back and closely read the reasons who these pundits cited for their bullish stances at the beginning of 2012. When one does this, it becomes quite clear that, almost without exception, these folks did not "get it right" in 2012. Indeed, almost every single one of these bullish managers, strategists and commentators got it wrong. In golf terms, these folks "shanked it," the wayward ball bounced fof a tree trunk and then landed on the green. Rather than be proud of their "results," on the scorecard they should embarrassed by their fundamentally unsound and often amateurish swings. It would be foolish to bet favorably on the performance of such players for the rest of the course.
In 2012, the performance of US stocks was essentially "middle-of-the-pack" as far as annual performances go. We make no judgment in this article on whether 2012 returns were "worth it" on a risk-adjusted basis.
What caused this absolute and relative performance in 2012? Who got it right?
In 2012 about 65% of fund managers and almost 90% of hedge fund managers underperformed the S&P 500. Furthermore, for reasons detailed in this article, the vast majority of fund mangers, strategists and pundits that outperformed in 2012 actually got it wrong - i.e. their cited rationales for bullish stock performance in 2012 were proven to be completely misguided.
Let me be clear: The stock market did not perform in 2012 as I expected either; the overall performance of my recommended asset allocation strategies in 2012 emphasizing high cash positions (including ST bonds) trailed the total returns of the S&P 500 index - returns that could have been passively obtained by blind commitment to instruments such as (SPY) or other similar index ETFs such as (DIA) or (QQQ).
Therefore, in my next article, I am going to review what actually happened in 2012 and answer two questions: 1) Why did the equity market perform as it did in 2012? 2) If I could have a "do-over," what would I do differently?