[dropcap]T[/dropcap]he first week of 2012 was a quiet one. The US economy continued to show signs of recovery, with unemployment dropping to 8.5% and new construction numbers exceeding expectations. Increased tension with Iran and ongoing concern about Europe dampened enthusiasm, but stocks finished higher anyway. All of the gains for the week came from a rally on the first trading day of the year. The Euro declined against the Dollar for a 5th straight week.
S&P 500: 1,277 (+1.6%)
MSCI EAFE: -0.7%
US 10-Year Treasury Yield: 1.96% (+0.08%)
Gold: $1,616 (+3.4)
EUR/USD: 1.272 (-1.7%)
- Tuesday – China announced manufacturing returned to growth in December after a decline in November.
- Tuesday – Germany reported unemployment fell to 6.8%, ahead of expectations.
- Tuesday – Oil jumped 4%, to over $100 a barrel due to increased tensions with Iran.
- Wednesday – UniCredit, Italy’s largest bank, announced a 7.5 billion Euro share offering, reducing confidence in the capital positions of European banks.
- Thursday – President Obama released a plan to reduce military spending. The initiative would scale back the ability to wage two simultaneous ground wars, but could save $487 billion over ten years.
- Friday – The Labor Department jobs report showed the US economy added 200,000 jobs in December, lowering the unemployment rate to 8.5%.
- Friday – Fitch followed S&P and Moody’s by cutting Hungary’s debt rating to BB+, or junk, due to concerns about “unorthodox policies” related to the autonomy of the country’s central bank.
Early last summer, we wrote that US economic improvement would be an unexpected surprise that should boost the markets. Indeed, it played a key role in the fourth quarter rally. Much of the surprise is now gone, however, and consensus expectation is for the domestic economy to continue to slowly improve. This means less upside for the market even if things go relatively well. Still, there are two surprises we believe could drive stock prices meaningfully higher.
- US home prices start to rise. Home prices have already begun to level off, but there is heavy skepticism that they can turn the corner and start to increase in 2012. In our mind, improving employment, high rent prices, and historic low mortgage rates make a strong case for rising home prices sooner than most expect. This would reduce pressure on banks and create all sorts of new economic activity.
- Europe avoids recession. This one is more of a long shot. We share the common view that Europe will have to endure recession. But if we are wrong, which is always possible, it would create a pleasant surprise for global capital markets. Remember, most people expected the US to double-dip and were wrong. The same could easily happen in Europe. The declining Euro has concerning longer term implications for Europeans, but should boost export driven demand in the meantime. Europe has been excessively reliant on government spending. If governments must cut back due to the debt crisis, it will create short term pain. But it could be massively bullish if the more productive, and somewhat less corrupt, private sector picks up the slack.