Perspective on markets at the close of 2011

With the close of 2011 behind us, we might want to reflect on the stock and bond markets and what they may be telling us about the future.

One year ago ,the economy was recovering -- stocks were in a clear uptrend, the Federal Reserve had short term interest rates at levels not seen since the 1950s and was about to print a lot of money through QE2, fiscal stimulus (deficit spending) was about to be $1.5 trillion (more than 10 percent of GDP), and we were about to enter the third year of a president's term, which traditionally has been the best of a four-year cycle and has averaged 16 percent for U.S. stocks since the 1930s.

Should have been a great year for stocks but not so good for bonds.

That's not what has happened. It was a great year for bonds and a not so great year for stocks. Most consultants and forecasters got it wrong!

As a matter of fact, most forecasters have been getting it wrong since this decade began. The S&P 500 with dividends reinvested have produced less than one half of 1 percent positive return since 12/31/99. On the other hand, bonds as measured by the Barclay's Govt./Credit Intermediate Index has produced nearly a 6 percent annualized total return.

Asset allocation determines 70 percent to 90 percent of an investors long term return. If your consultant/advisors had you over allocated to stocks vs. bonds in this century, your performance has suffered.

Why hasn't the stock market performed well this century? Why hasn't the stock market performed well this year, with the unprecedented levels of monetary and fiscal stimulus? Why have interest rates gone down to levels not seen since the 1950s causing the bull market in bonds to continue?

The answer: Developed markets do not need capital because their growth will be slowing.

Why will it be slowing? Developed nations are and will be reducing levels of debt. We have begun a debt super cycle reduction.

From 1950 to 2000, corporations, households and governments borrowed heavily to spend, which caused well above average growth. Debt as a function of income levels essentially tripled. The free world leveraged up. Corporations began to reduce debt in 2002 and households with the housing market collapse in 2008. Starting with Europe, sovereign debt needs to be reduced. The United States is not far behind socialist Europe.

For example, for 2011 the GDP in the United States will be about $14.9 trillion. If we took away the $1.5 trillion deficit spending by the federal government our adjusted GDP would be $13.4 trillion. Our markets are reacting to the fact that we will eventually (2013 & 2014) begin to reduce the deficit. This means less federal government spending and higher taxes, which reduce growth.

Printing money has been our solution thus far as it has been in Europe. Printing money makes a nation poorer. It affects the poor more than the rich. I believe the growth in the money supply in the U.S. for 2011 will be +10 percent as measured by M-2.

With fiscal stimulus (i.e., deficit spending) at more than 10 percent and monetary growth at +10 percent (i.e. 10 percent more money chasing goods and services), it is disappointing that the GDP growth for the year is only +3 percent.

The mega trend is for continued correction of debt in the debt super cycle. I believe we are nearing the end of the great bull market in bonds. Expect less powerful bull markets for stocks mixed with more frequent bear markets. Returns for stocks and bonds should be well below average over the next 2 to 4 years.

Emerging markets should offer better opportunities.

Long term, the bond market looks risky especially in the developed nations. Stocks will eventually do better.

In this low return environment, we like several closed-end funds that own world class companies, that pay 2 percent dividend yields and that write options against their portfolio's adding another 8 percent annual return, which can be bought at double digit discounts to their net asset value producing a 12 percent payout to investors.

We continue to like preferreds issued by closed-end bond funds that have 3 to 1 liquid asset coverage as the ultimate safe investment. Should the asset coverage ever drop below 200 percent, the funds are required by an Act of Congress to liquidate portfolio securities and repurchase the preferreds at par thus giving an investor his money back at a time the fixed income markets are in severe duress.

Navigating the markets is what we have done well over the last 25 years. Reasonably correct perspective of the markets is critical to long term investment success.


George W. Karpus is chief investment strategist and chairman of the board for Karpus Investment Management, an independent, registered investment advisor that manages assets for individuals, corporations and trustees. Offices are located at 183 Sully's Trail, Pittsford, N.Y. 14534; phone (585) 586-4680.

Published: Thu, Jan 5, 2012