The Road Ahead

So what’s the outlook for 2012?

For the record, we believe that next year will bring a continuation of the modest growth we’ve seen since the recession. The economy will grow around 2 ½ percent, as we work off the excess housing stock brought about by the boom and bust. Interest rates will be largely unchanged, and the stock market will reflect the economy’s modest recovery.

There are risk’s to this scenario, particularly from Europe, which appears to be in a mild recession right now—brought about by a credit crunch, as banks there deal with the sovereign debt crisis. But there are significant risks to the upside as well: a housing recovery could emerge here ahead-of-schedule; manufacturing in the US is growing due to higher costs overseas; new energy supplies provide some insulation from supply shocks; mobile technology and smart phones are boosting productivity and investment; and Congress seems to be stumbling toward greater fiscal responsibility.

As these factors come together analysts give little or no credence to their likelihood. Current stock prices assume a coming collapse in earnings. High profits now are deemed to be unsustainable, even as the companies in the S&P 500 continue to do better than expected. Future cashflows are being discounted at a higher interest rate than we see right now because everyone expects rates to rise.

But you can’t have it both ways. If rates rise because the economy strengthens, then earnings will strengthen, too. If rates stay low, those future cashflows are more meaningful today as discount rates are lower. Either way, stock prices should rise.

Here’s hoping that 2012 will bring good news, and that our cautious optimism will be tested—to the upside.

Douglas R. Tengdin, CFA
Chief Investment Officer
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