Market Update – January 2012

In a lot of ways, the beginning of 2012 looks a lot like the beginning of 2011, with a resurgent stock market, positive economic indicators pointing toward an economic recovery, and a still-sluggish housing market that continues to struggle to get into gear.

Of course, we all now know that the encouraging start to 2011 did not prove to be enduring. The year was plagued with political gridlock in Washington and economic instability in Europe. Despite these obstacles, the year ended on a positive note, with the Dow Jones pushing back over 12,000 and unemployment at a two-and-a-half year low of 8.6%.

Perhaps the biggest difference between the start of 2012 compared to the start of 2011 is that the risks going forward are more obvious to the casual observer. To begin with, in case anyone hasn’t noticed, 2012 is an election year and the country remains as polarized as ever. The likely result is that the gridlock in Washington will continue. The House remains in Republican hands, and the Democratic majority in the Senate is too small to prevent frequent Republican filibusters of anything the minority party doesn’t like (and they don’t seem to like much).

Both parties show every sign of remaining hostile throughout 2012. This gamesmanship is infuriating to most of us average Joe’s who just want the government to do something useful to help solve our economic problems. But underlying these disagreements is the much bigger issue between the two parties over the size and scope of government in the daily lives of the American people. These differences are fundamental and profound. Until one side or the other gets a bigger majority – and most especially, until the Presidential election is decided – I think it’s fair to say that we will not be seeing much cooperation or constructive government intervention in the economy.

Meanwhile, on the other side of the pond, the economic issues and challenges are, if anything, even more profound. I’m talking of course about the on-going and serious debt crisis in Europe. Despite repeated efforts to solve it, the debt markets remain skeptical that the European Union has intervened enough, or in the right ways.

This past December, two significant steps were taken to address this problem. The jury is still out on whether either will be sufficient to make a difference.

On December 9, all but one of the 27 European Union Countries – the United Kingdom being the sole exception – agreed to work toward a new and tougher set of rules designed to restore fiscal balance to the Eurozone. Sounds good, but what the markets really wanted and expected was greater support for the floundering sovereign debt of the weakest members of the Eurozone. This support would, most credibly, have come from the European Central Bank (ECB) by promising to guarantee the bonds of all Eurozone members. But this is not what Angela Merkel, Chancellor of Germany, wanted. So it was not was the markets got.

But then, in the second significant development of the month, the ECB announced on Dec. 21 that it would lend €489 billion (equal to US $639 billion) to struggling European banks to give them some much-needed additional liquidity. If the Dec. 9 meeting was a disappointment, the ECB move was a hit, driving down borrowing rates and pushing up the markets, at least for a while.

Since then, the bond markets have been up and down, an indication that recent developments may have helped, but haven’t solved, the debt crisis in Europe. So we enter a new year with lots of reasons to be encouraged, but also lots of reasons to worry. As always, we’ll just have to stay tuned and see what unfolds next. At the very least, 2012 looks to be an interesting year.