FOURTH QUARTER & 2011 REVIEW

01/03/2012

Market Summary

• Stocks:  rebounded broadly in Q4; S&P 500: +11.8% in quarter, +1.9% YTD (with dividends).
• Treasuries:  slight price gains / lower yields; 10 Yr Yield: 1.87%, down from 1.92% @ Sep-30.
• Corporate Bonds:  solid Q4 gains; meaningfully outperformed comparable maturity Treasuries.
• High-Yield Bonds:  strong Q4 recovery and full year net gain.
• Crude Oil:  $98.89, up from $78.64 @ Sep-30 and down from $105.50 a year ago.
• Natural Gas:  $2.97, down from $3.66 @ Sep-30 and lowest since Oct-10.
• U.S. GDP grew 1.8% in Q3 (annualized), accelerated from +1.3% in Q2. 

 

		Average Annual %
Historical Results	Q4	1 Yr	3 Yrs	5 Yrs	10 Yrs
Short-Term Treasury Fd (Vanguard-VFISX)	0.3	2.4	2.0	4.1	3.8
Intermediate Treasury Fd (Vanguard-VFITX)	0.9	10.2	4.8	7.6	6.4
Intermediate Inv Grade Bond Fd (Vanguard-VFICX)	1.9	7.9	11.7	6.9	6.2
High-Yield Bond Fd (Vanguard-VWEHX)	6.1	7.4	19.2	6.1	6.9
S&P 500 Stock Index Fd (Vanguard-VFINX)	11.8	1.9	14.5	-0.3	2.7
Small Cap Stock Index Fd (Vanguard-NAESX)	15.0	-3.4	20.4	1.8	6.5
International Stock Index Fd (Vanguard-VGTSX)	4.2	-14.1	9.5	-3.5	5.9
Balanced Composite (50% Treasury Fd / 50% S&P 500 Fd)	6.3	6.1	9.7	3.6	4.5
Data includes reinvested income

 Overview

Financial markets remained volatile in the fourth quarter (Q4). The still unfolding European Union (EU) debt crisis continued to dominate headlines and undermined global confidence. Investors remain cautious, but also appear to be adjusting to EU reality and the prospects of slower and regionally uneven economic growth. Our resilient U.S. economy posted improving data throughout the quarter and helped boost sentiment from the deeply negative reactionary levels reached in Q3. Data released during Q4 indicates that after decelerating in late summer and early fall, growth in most emerging economies may be stabilizing at lower levels as well.

For the quarter, stocks recovered substantially from oversold lows. Treasury bonds extended gains after rallying sharply in a third quarter flight from risk. The ten-year Treasury yield ended the year at 1.87%, up from an early October and fifty+ year low of 1.70%. Investment grade and high yield bonds (HYB) rebounded solidly. In short, asset classes that performed best in the final quarter of '11, were among those that became most attractively priced during an eight-week round of risk reduction and indiscriminate selling in Q3.

For the year, stocks ended mostly lower as first and second quarter gains were reversed in Q3, and then prices recovered substantially in Q4. U.S. stocks in defensive sectors performed best. Treasury bonds produced big gains, mostly in the second and third quarter on the global flight from risk. Investment grade bonds posted solid gains and high yield bonds produced respectable total-returns, helped by Q4's rebound.

There appears to be a broadening belief that the global economy is steadying, with emerging signs of U.S. leadership. From a first quarter low of +0.4%, U.S. GDP expansion accelerated to +1.3% in Q2 and +1.8% in Q3, with Q4 expected to continue that trend. This comes after the March earthquake and nuclear reactor meltdown in Japan, a mid-summer activity stall in reaction to the U.S. debt ceiling debacle and a rapid deterioration of confidence in the Europe Union's (EU) ability to comprehensively deal with its debt crisis. The EU is under pressure from financial markets and the situation is fluid. Even as progress is made, EU political leaders are being forced to quicken the pace of agreement and implement policies to stabilize the most indebted and fiscally challenged members of their monetary union. Quite possibly, one or more of the strategically least important of the fiscally irresponsible countries will be extricated at some cost. There are reasons like self-interest among its stronger members, to be optimistic that the EU, with help from the ECB and IMF, will put in place credible plans that reasonably satisfy global financial markets. No short-term fix exists; EU headlines will, at times, substantially influence financial market direction. There is, however, a developing sense among investors that the situation in Europe will not lead to a sharp/sustained global economic contraction. In Asia, China's efforts to moderate its world leading economic growth rate appear to be working, but concerns persist that a hard landing is underway. Most other Asian economies appear to be doing reasonably well. With economic growth slowing, inflation pressures have eased. Globally, central bankers continue to provide tremendous liquidity, which should help keep short term interest rates and longer term yields low well into '13.

Clearly, there are risks. However, stocks and corporate debt appear to be attractively priced to discount current uncertainty. We think stocks should do well over time. Dividends have been rising and yields are historically high. Stock market capital is being allocated to sectors and companies with relatively better business visibility and solid growth expectations. We like reasonably priced U.S. leaders of all sizes that compete and win domestically and globally. Fixed income investors are cautiously increasing their commitments to attractive credit risks. After widening in the fall, yield spreads over U.S. Treasuries are compelling for investment grade and high-yield corporate bonds and for select developing and emerging market corporate and government bonds.

S&P 500 with 20 & 50 day moving average

10 Year Treasury Yield: 1.87%, -5 bps in Q4

GPM Review and Performance

Correlation among risk-oriented assets continued, but in this quarter most classes advanced.

The large-cap S&P 500 gained 11.8% in Q4, following a loss of 13.9% in Q3 and gains of +0.1%, +5.9% and +14.9% in Q2, Q1 and full year '10, respectively. Q4 returns on other major stock market benchmarks ranged from -15.7% (Vietnam ETF) to +26.4% (U.S. Regional Bank ETF). Most countries registered gains in Q4, with U.S. markets clearly favored. After selling down the most in Q3, small and mid-caps rebounded sharply to lead in Q4. Most sectors advanced, with an encouraging leadership mix of defensive stocks and cyclicals that were bruised in Q3. Most countries, indices, sectors and stocks ended down for the year in 2011.

GPM growth accounts rebounded with the broader market in Q4. YTD performance was slightly below breakeven.   80% of our individual stocks and 100% of our stock ETFs and mutual funds posted gains in Q4.   GPM growth accounts can be allocated up to 100% in stocks.   At quarter-end, our net-long position in stocks was about 70%, essentially unchanged from last quarter.  Full year 2011 averaged 76% up from 71% in 2010.   An additional 10% is in high yield corporate bonds. GPM stock portfolios were weighted about 43% large-caps, 15% mid-caps and 42% small-caps, from 40%, 20% and 40% respectively, three months ago. Non-U.S. stocks comprised about 8%, down from 20%. We trimmed foreign stock risk and raised our weighting in U.S. companies and high-yield bonds.

We hold a larger than usual cash buffer; some is used for shorter-term investing. Longer-term, as global uncertainty recedes, most cash will be put to work in GPM focus stocks. We favor companies that have been delivering solid to strong sales and earnings growth, with healthy balance sheets and robust cash flows to fund growth and boost dividends. For many companies today, the dividend yield on their stock is greater than the interest paid by their bonds.

GPM taxable bond accounts posted solid recovery gains in Q4, following a disappointing Q3. For the year, bond accounts ended slightly positive and underperformed key benchmarks. Taxable bond accounts have registered positive returns in twelve of the past thirteen quarters and twenty-two of the past twenty-three years. All components gained in Q4, led by high yield and investment grade corporate bonds, Asian debt, GNMA's and diversified global bonds. Q3's detractors to bond portfolio performance were solid positive contributors in Q4. Full year bond portfolio performance was hurt by the third quarter loss. At year-end, portfolio cash flow generated in GPM's fixed income accounts was about 4.0%, resulting in a yield more than two times that of a ten year Treasury.

GPM balanced accounts posted strong rebound gains in Q4. YTD performance was slightly below breakeven. As discussed in the two paragraphs above, Q4 performance was positively impacted by all portfolio components. The rebound in stocks and high yield bonds contributed most positively, followed by corporate and global bonds. GPM's balanced portfolios employ a flexible approach that combines individual securities, ETFs and mutual funds.

GPM tax-free bond accounts extended gains in Q4 to cap-off a strong year. Municipal bond price gains added to steady bond income to produce a solid total return. Muni bond market sentiment improved throughout the year as state and local tax revenues continued to increase. Default levels remain very low and municipal borrowing costs are at historically low levels. At quarter-end, portfolio duration was less than five years and cash flow yield is well above the yield on a ten year Treasury and nearly equal to a thirty year.

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By early February, you will receive 1099s; realized gain/loss reports, which include investment cost basis, and other related 2011 tax information from Charles Schwab and other custodians.

Thank you for allowing GPM to serve as your investment manager and advisor. We encourage you to periodically review your portfolio and investment goals with us.

We hope that you and your family have a happy and healthy New Year.

As always, we encourage you to contact us for any reason.

Sincerely,

The GPM Team