It's the time of year to review the past and ponder the future. Investors have a lot to be grateful for in 2012. They also have a good amount to consider heading into 2013.
2012 was yet another year filled with economic headwinds. For the third consecutive year in this recovery, the U.S. economy delivered disappointing growth. Our biggest export market, Europe, entered a recession and growth slowed in the emerging markets. Investors had to deal with the uncertainty of a hard-fought election cycle and are now focused on important political battles over taxes and spending.
All in all, the financial markets had a lot to handle in 2012 and did so remarkably well. Stocks are up double digits and bonds continued their astounding run.
Despite the softness in the leading economic indicators and strong evidence that corporate earnings growth is slowing, it appears a sense of complacency has washed over investors. As we look forward to 2013, wise investors should remain alert and adopt three financial New Year's resolutions.
Resolution 1: Don't overestimate the Fed's abilities.
The Federal Reserve has not discovered the secret to preventing future recessions. With its zero interest rate policy, it is clear the Fed is trying to distort asset prices. Investors would be unwise to compare every potential new investment — regardless of risk — to the alternative of earning near-zero interest sitting in cash or earning very low yields holding short-term bonds. Doing that is about as smart as encouraging a teenage girl to compare herself to that starving model on the cover a fashion magazine.
Resolution 2: Don't bank on such robust corporate profits.
The most amazing story of the stock market's recovery from its '09 low has been the ability of corporations to produce such strong profit growth in such a slow-growth economy. They've largely met the moderately recovered demand for their goods and services without needing to hire many new workers or to pay much more to existing employees. This has resulted in an explosion in corporate profit margins. Some studies point to no other time in modern history where profit margins have been this elevated. Investors should remember there is a financial law of gravity, too. It's called, reversion-to-the-mean.
Resolution 3: Don't get too gloomy by the big picture or too giddy by past returns.
Given the negativity surrounding our politics and the discernible weakness in the data, it certainly doesn't take much mental effort to be gloomy about the future of our economy. And, given the excruciatingly low yields on high-quality fixed income investments and the surprisingly strong returns in the stock market, it is awfully easy to begin to chase returns. Blindly following the negative path or desperately casting aside your investment discipline are both equally unprofitable acts.
Jason P. Tank is a Chartered Financial Analyst and co-owner of Front Street Wealth Management, a fee-only wealth advisory firm located in Traverse City. He encourages questions and comments about future columns. Contact him at (231) 947-3775, by email at Jason@FrontStreet.com and at www.FrontStreet.com.