2011 Replay?

After getting off to a strong start in 2012, the stock market gave back nearly all of its returns in May. Fears over Europe’s financial crisis and slowing global growth, led many investors to take profits and either move to the sidelines or re-invest in US Treasuries. The market movements look very similar to 2011, when fears of a double-dip recession rattled investors in early summer.

Corporate earnings in the US have remained fairly strong, especially in the manufacturing sector. US stocks remain at attractive valuations compared to historical levels, but aren’t likely to experience significantly expanding P/E ratios in this slow global growth environment. Bonds remain relatively unattractive at current levels (10 year Treasury near 1.6%). Interest rates are likely to remain near historically low levels for the next couple of years as developed markets continue to deleverage and investors continue to buy US Treasuries for safety. If economists are right, and we do see 2-2.5% domestic GDP growth over the next 12 months, US stocks should still be the favored asset class due to their strong cash flows and balance sheets and reasonable valuations.

We are likely to get heavy doses of volatility until Europe works through its financial and political issues, until after the US presidential election and budget cuts, and until China’s growth stabilizes. Therefore, it is important that investors have their portfolios in line with their overall risk tolerance and maintain plenty of liquidity for living expenses in the form of cash and short term bonds.