For those who watch the investment markets, the first half of 2012 was a strange and somewhat harrowing experience. The first four months of the year saw American stocks zoom upward by almost 10 percentage points, building on one of the best January performances in history. Then came May, when the Wilshire 5000–the broadest index of U.S. stocks–gave back 6.22% of its value. June was a muddle–until the final day of the month, when The Wilshire 5000 gained back 2.53% in a single trading day and essentially saved the quarter from being considered a total disaster. On the same day, the S&P 500 gained 2.49% and the Nasdaq exchange was up 3.00%.
If there is a lesson here–and the markets are always teaching us new ones–it is that the drops, and the rises, take us by surprise, and are almost impossible to predict.
Let’s take stock of the past quarter, and look at where we are after the first half of 2012. Overall, the Wilshire 5000 fell 3.13% for the second quarter, but it’s still up 9.22% for the year. The comparable Russell 3000 index fell 3.15% during the second quarter, but rose 3.92% in June, and is up 9.32% for the year.
The other stock market sectors moved in a very similar pattern. Large cap stocks, represented by the Wilshire U.S. Large Cap index, fell 3.11% for the quarter, but are posting a 9.15% overall gain in the first half of 2012. The Russell 1000 large-cap index fell 3.12% for the second quarter, but is up 9.38% for the first half of the year. The widely-quoted S&P 500 lost 3.29% in the same time period, but is up 8.31% this year.
The Wilshire U.S. Mid-Cap index was the biggest quarterly loser, down 5.71% in the second three months of the year, but it, too, has posted an overall gain so far this year, at 5.93%. The Russell midcap index dropped 4.40% in the recent quarter, but is up 7.97% so far this year.
The Wilshire U.S. Small-Cap index dropped 3.33% in the three months ending June 30, but ended the first half up 9.54%. The Russell 2000 small-cap index lost 3.47% in the three months ending January 30, but is up 8.53% for the first six months of 2012. The technology-heavy Nasdaq Composite Index lost 5.06% in the second quarter, but was up 3.81% in June, and has a 12.66% gain for the year.
Although energy stocks are down 3.37% for the year, as a result of falling oil prices, other sectors are posting significant gains. Telecommunication services stocks are up 13.34% for the year, while information technology stocks have posted a 12.71% gain, even though they fell 6.96% during the second quarter. Financial stocks are up 12.63% and Consumer Discretionary stocks have gained 12.06%.
Internationally, the broad-based EAFE index of developed economies fell 8.37% for the quarter despite a 6.79% gain in the past month. For the year, the index is up a scant 0.77%. Not surprisingly, the weakest component is EAFE’s Europe index, down 9.11% for the second quarter, down 0.12% so far this year.
The EAFE Emerging Markets index of lesser-developed economies fell 10.00% in the second quarter, but is up 2.29% for the year. The bloodiest quarter was experienced by the Eastern European EM countries, down 15.03% in the three months ending June 30, but still up 0.38% for the year.
Commodities are generally down for the year, with the S&P GSCI index falling 12.38% in the second quarter, down 7.23% so far this year. The hardest-hit: energy (mostly oil) down 17.05% for the quarter, down 10.98% so far in 2012.
On the bond side, U.S. Treasuries remained at rock-bottom yields. The 12-month T-Bond yields just 0.20%. Locking up your money for three years gets you 0.39% a year. Ten-year issues yield 1.64%, and 30-year Treasuries bring a 2.75% annual coupon yield. Muni bonds are even lower, with yields of 0.211% (1-year), 0.343% (2-year), 0.808% (5-year) and 1.922% (10-year), while the aggregate of all AAA corporate bonds is yielding 1.14% for bonds with a five-year maturity.
It is worth looking at what led to the sudden jump in investor enthusiasm for stocks on the very last day of the quarter, and see whether we should be feeling the same exuberance as the general public. The market jumped on preliminary news that a late night round of negotiations among the Eurozone leaders had led to a “breakthrough” (as the news reports called it). Over the weekend following these news reports, we have learned more details: the European leaders have decided that instead of lending more money to the Spanish government, and possibly eroding its already shaky creditor status, they will inject bailout funds directly into Spanish banks. In addition, the leaders agreed to use the bailout funds set aside in the European Financial Stability Facility and the European Central Bank “in a more flexible manner” in order to stabilize the Eurozone markets. Finally, the leaders announced plans to create a 120 billion euro fund to stimulate growth across Europe and create jobs.
All of these moves represent at least a quarter-degree turn from previous policies. Giving money directly to the Spanish banking system avoids a negative feedback loop where lending to the government simply burdens it with more debt and causes investors to demand cripplingly high interest rates on Spanish government bonds. Making the bailout funds more flexible seems to be a concession by German government leaders, who wanted any bailouts to be accompanied by austerity measures in the receiving country, which has, so far, weakened every economy that agreed to it. The growth funds seem to be a step in the same direction, away from austerity toward promoting growth and employment–which avoids the negative feedback loop of austerity causing economic hardship, leading to declines in GDP, leading to lower tax revenues, leading to deeper fiscal deficits, which is what the bailouts were intended to alleviate.
However, as investors read the fine print, they will notice that the newly-flexible bailout funds amount to about 500 billion euros, compared with roughly $2 trillion in potentially distressed government debt. It is possible that some of the enthusiasm generated on the last day of the first quarter will have evaporated within the week, following a well-worn path of enthusiasm followed by panic that investors who are paying attention will have already grown tired of.
Meanwhile, there is some cause for concern in the U.S. economy, which has recently seen the kind of good news that should be put into better perspective. The number of Americans filing for first-time unemployment benefits fell to 386,000 for the week ending June 23, down from 392,000 the previous week. But the four-week average fell by just 750, meaning that if you look past the headlines, an economist would have trouble discerning a trend in the data. Similarly, home prices in the 20 largest U.S. cities rose 1.3% in value in April, based on the S&P/Case-Shiller Home Price indices. But this, too, calls for some perspective: the rise only brings home prices to levels seen in early 2003.
Is there a pattern here? Investors have been led to believe that the global situation, and the U.S. economic trends, were worse than an objective view might indicate, and then, in one day, they were suddenly seeing unexpected positive news that may have been overhyped. The truth is that Europe is still working its way out of a crisis, and many analysts are still predicting a recession in the Eurozone this year. The U.S. has been on a slow recovery path, and it is not easy to predict its progress beyond feeling grateful that the situation is not as dire as we see in Greece, or as unsettling as what we’re seeing in Spain.
The most truthful thing one can say is that these sharp turns in the market–in May, on the last day of June–are not driven by any change in the intrinsic value of stocks, or any interruption in the actions of millions of workers who are daily building stronger, more profitable franchises throughout the global economy. The lurches of the roller coaster represent emotional responses by skittish investors who want to jump into or out of the markets based on headlines that usually seem to overstate the case on the upside and the downside.
So far, 2012 has been a very bumpy ride, and has certainly been scary at times. But from a real investor’s point of view, behind all the sturm and drang, the first half of the year has seen unusually positive growth in the markets. We cannot predict what the second half will bring, any more than we can predict what the weather will be at a certain date in October or December. Remaining steadily invested and paying as little attention as possible to the shrill voices of our increasingly frantic news outlets has been a solid strategy so far this year, and has generally worked out well for investors over time.
2012’s second half will undoubtedly bring us more surprises. It will force us to remember that we are not investing in current events, but in the far more boring, far more significant daily work and effort of the people who get up each morning and contribute to the growth of our global economy and the growth of the businesses they work for–the companies that we, together, are invested in.