Elections Over. Fiscal Cliff in Focus.

Stocks started 2012 with solid gains and then added to them during the year. Most major asset classes made money during the year.
Despite being three years into the current economic recovery, stocks and many other risky assets started 2013 with a bang. Small cap stocks, international stocks, and high yield bonds have been particularly good thus far. Resolution of the Fiscal Cliff was clearly the initial factor, but there are other fundamental contributors to current optimism as well.  The following data points are available from the Federal Reserve Bank of St. Louis.
• Oil production continues to grow within the United States thanks to hydraulic fracturing or “fracking.” Natural gas production, which is growing from the same process, is also likely to continue at its elevated levels. This industry has provided jobs to approximately 50,000 workers in the last three years and is still increasing its employment numbers at a rate of 6.5 percent.
• The growth in the supply of natural gas and oil has also provided lower energy costs for consumers and manufacturing. After 10 straight years of job losses in manufacturing, this industry is now experiencing three years of employment growth around 2 percent.
• Consumers are in a better position to increase spending and saving. Household debt is 10.5% of disposable income, which is the best level since the early 1980s.
• The housing market is improving. Prices of existing homes rose over 4% (Case-Shiller 20 City Index) in the last year. Housing starts and permits are each up 20%.
• Even after the recovery began in 2009, state and local governments were reducing their work force. This placed a short-term drag on the economy by reducing consumer confidence and spending. Half a million workers lost their jobs. Now it appears that many of these governments have their fiscal house in order.
The hemorrhaging may have run its course. The negative factors may now turn positive.
• Inflation, measured by CPI, is just below 2 percent. This will provide the Federal Reserve the flexibility to continue to focus on stimulating the economy in order to create more jobs. The efforts of the Federal Reserve are certainly a large part of the current recovery and will likely continue to play a role in 2013.
Of course, all this opportunity for growth comes with a price. Investors don’t have to love risk, but they do have to live with it. It is a tool to be managed carefully in order to participate in the long-term benefits of investing.
Many of the positive factors that drove the market upward last year are still in place this year. Indeed, the current year started off with a similar jump as that in 2012. While history will not repeat itself exactly, hopefully it will rhyme.

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