What went on in 4Q 2011

Global equities posted a gain for the fourth quarter.  This helped assuage investors' fears that the markets were in for a new round of sustained declines, and it does appear that "a bottom" was reached in September.  The S&P Developed Ex-U.S. BMI gained 3.3% in dollar-denominated terms for the fourth quarter. Among the large markets, the U.K., Switzerland and Germany posted the greatest gains, while Japan and Singapore declined the most. From an economic sector perspective, energy, health care and consumer staples rose the most, while financials and utilities stocks posted negative returns. In the U.S., the Russell Midcap Index was up 12.3%, reflecting that investors were focused on the fundamentals of companies.  Economic sector returns were quite varied for the quarter, with energy up 22.0%, while telecomm rose just 1.5%.

 Though not nearly as difficult as 2008, 2011 was a challenging year for the equity markets.  The market capitalization of global equities declined -11.7% in 2011 to $45.9 trillion, removing $6.3 trillion in value.  The majority of negative returns were centered in international markets, as European broad cap indexes declined -11.5% and the Pacific Region outside Japan fell -12.9%.

U.S. small and mid cap stocks had a particularly tough time, and the Russell Midcap declined -1.6% for the year. Russell index returns were driven by both size and style, and growth stocks beat value issues everywhere but in the mid cap space.

 Much of the past six months presented a difficult market environment for stock picking, as investors whipsawed between two vastly different views of future economic environment -- risk on and risk off.  This caused correlations and volatility to spike, as market participants oscillated between a world view of solid economic growth and debt-driven recession. The good news is that correlation peaked in August 2011and has been trending downward since then, reflecting investors' increased confidence that the European debt crisis will come to a resolution which will not completely derail global economic growth.

 Looking forward, corporations will have a more difficult time sustaining earnings growth which, despite the dire headlines, was quite robust in 2011.  However, we believe the market looks attractive, given that corporate profits should increase in 2012. The fact that there continues to be access to liquidity in the financial system should help the capital markets, in addition to corporations still accelerating their capital spending.