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Third Quarter 2012

The market’s performance during the third quarter of 2012 was surprisingly good.  Despite negative sentiment, slow growth, high unemployment, China, debt crisis in Europe, fiscal cliffs and the like, both Equity and Fixed-Income markets have advanced both in the quarter and year-to-date.  How can markets advance in the face of so many problems?  Of the hundreds of moving parts that contribute to changing market prices, some are insignificant and others become critical as times change.  Right now the dominant factor in market pricing is the central banking system of the United States:  The Federal Reserve.

We state again, we are in the midst of a combined monetary infusion cycle of historic magnitude, resulting in one of the most dramatic market environments since the creation of the Federal Reserve 100 years ago.  The combination of Federal Reserve plus legislated stimulus action serves to create additional money supply.  The outcome is rising prices, markets moving up despite a challenging economy, plus inflation. With no business incentive to spend and banks unwilling to lend, the additional money supply has not fully worked its way into the system; but it will.

The Economy.  The Conference Board uses ten “Leading Indicators” to predict how strong the economy will be in the coming nine months.  The numbers remain about the same, indicating not much growth at present.

FEB	MAR	APR	MAY	JUNE	JULY	AUG
95.5	95.6	95.5	95.8	95.3	95.8	95.

Leading Indicators usually change before the economy as a whole changes, and are therefore useful as short-term predictions of the economy.  Lagging Indicators usually change after the economy as a whole changes.

Leading Economic Indicators	Lagging Economic Indicators
New unemployment claims	Unemployment rate
Manufacturers’ new orders	Value of outstanding consumer loans
New building permits	Consumer Price Index
Stock Market performance	Labor cost per unit
Money supply	Consumer credit/Personal income
Index of consumer expectation	Prime rate

The stock and Bond markets can move in the same direction as the economy, but often do not.  The complex factors that cause economic indicators to change are very different from the factors that move the markets.  Oftentimes we hear of direct correlations between economic growth and performance of securities markets, which in fact may not be the case.

The Gross Domestic Product (GDP) is a measure of total output of goods and services produced in the United States.  It is compiled by the Bureau of Economic Analysis.  The Second Quarter GDP was up 1.5%.

The Consumer Confidence Survey, which is a solid measure of the spending strength of individuals, produced numbers that are very jumpy, signaling confusion in the attitudes of US consumers.

APR	MAY	JUNE	JULY	AUG	SEPT
68.7	64.4	62.0	65.4	61.3	70.3

Market Valuation.  Corporate profits are expected to reach $105 per share this year, which would be an all-time high for earnings.  We are still using a rather low multiple of 14 times for the S&P 500, reflecting uncertainty that faces the markets.  Anything that would stimulate money flowing out of Fixed-Income and into Equities would produce an immediate spike in this multiple.  But at 14, a fair market value for the S&P 500 by year-end would be 1470, and since we are very close to that number the S&P 500 is now fairly valued.

Market results for the third quarter of 2012 were: