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Thoughts About 2012

Major issues cloud the outlook for 2012.  Fiscal policy remains in limbo, while the country revs up the presidential election campaign.  Finances in Europe remain a work in progress, yet the risk of a globally troublesome misstep remains intact.  There is also no shortage of geopolitical risks around the world, including Iran, the entire Middle East, and a new regime in North Korea.  Domestically, the economy is holding up fairly well and even seems to be gathering some upward momentum.  But will the economy be permitted to build on these trends, or will some external factors undermine the recovery?  The answer is unclear, which is why market is so cheap.  Patient investors should do well.  But it is likely to be another year that test investor’s mettle.

Gradual economic expansion and strong profit performance were offset in 2011 by financial turmoil in Europe and a political impasse at home to achieve an almost perfectly flat outcome for the major indexes.  A repeat performance can’t be ruled out.  Still, time appears to be on the side of investors.  The risk of a relapse into recession appears to have faded and a financial calamity in Europe would be necessary to push the economy over the edge.  Such a possibility can’t be dismissed, but it isn’t likely, since European governments are apparently willing to do whatever is necessary, even if only when it becomes necessary.  They have not impressed by their willingness to be proactive or to anticipate problems.  That is to their detriment and our nerves.  But as long as they take the steps needed to rein in deficits and force banks to accumulate capital, a credit crisis remains improbable.

Domestically, everyone will become ever more distracted by the election campaign, but the daily operations of the economy continue to improve.  Little is expected for the housing sector, so its recovery should prove to be a pleasant surprise.  That rebound in housing appears to be underway already and should become impossible to ignore in the first half of 2012, with very significant direct benefits to construction job growth and diffused but equally important benefits to hiring, income and economic growth generally.  There is a glaring need for major policy decisions on a variety of matters ranging from deficit reduction, health care policy and its financing, and tax reform.  Not much progress is likely in 2012, but little is expected.

The outlook for 2012 appears to be promising, but the downside risks, which are significant, insure that market conditions will remain volatile.  Still, Europe will likely continue to make progress on its financial problems and a rebounding housing sector will provide some additional impetus to growth.  This should enable the market to do better this year, albeit with some volatility.