Friday, January 06, 2012

From 2011 into 2012

FalkerInvestments’ investment strategy performed well in 2011, with equity returns of 7%, on average, as compared to flat price performance of the S&P 500 index. Our overall portfolios, which hold a mix of equities and bonds and were over-weighted toward cash during the year (depending on the risk tolerance of each client), also outperformed the S&P 500 benchmark. We are pleased with this performance given the high level of portfolio insurance afforded by our cash position during a turbulent year.

Europe’s sovereign debt problems dominated market psychology for most of 2011. The United States experienced a weak economic recovery, which was enough to at least partially offset concerns about Europe, and resulted in the S&P 500 Index ending the year almost exactly where it began, the first time that had happened in 64 years.

As we enter 2012, we will likely see a continued slow economic recovery in the United States. This is the result of several factors, including tight credit conditions in the private sector, limited fiscal stimulus due to growing levels of U.S. Government debt, and continued uncertainty about future government policy (e.g., financial regulation, taxes). At least one certainty has been the unprecedented support from the Federal Reserve. Given current conditions, the Fed has committed to a zero interest rate policy into 2013.

Unless some extraneous geopolitical or “black swan” event intervenes, it seems probable that the U.S. equity markets could increase moderately in 2012, treating Europe’s deepening recession only in terms of how it affects U.S. corporate earnings. Because U.S. financial institutions are intertwined in Europe’s affairs, they are the ones most likely to be affected, while multi-national industrial companies will fall back on their U.S. and non-European businesses.

We expect to capitalize on the good performance of our EVA-based equity strategy in 2012 by deploying a greater proportion of our client capital toward dividend-paying, value-creating equities, for those clients whose risk tolerance calls for equity investments. We think the valuation of the market, after zero appreciation in the past 12 months, now has a fair amount of risk-aversion embedded in it. This may well provide for a better-performing equity market in 2012 and, accordingly, we began this week to deploy at least some of our cash position toward high-quality stocks.

As always, we will be watchful of world economic and geo-political conditions, as well as being very selective about what we do. We are, however, encouraged by broader acceptance of these challenging conditions by investors and policy makers alike. Two years ago in this blog we spoke about an expected transition in the markets from excessive risk-taking to one of risk-aversion. That transition is underway and beginning to provide opportunity.

Thanks for your continued trust.

Jack and Peter Falker

January 6, 2012

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