Jeff For Banks

Guest Post: 2012 Economic Year in Review by Dorothy Jaworski

Looking Back at 2012

Every year, I usually write about the past year with mixed feelings, at times nostalgic for those events and at times, glad that the year is over. 2012 brought us highs, lows, and surprises. As to the latter, the Federal Reserve is always good for a couple of surprises. They continued to run their easing campaign, now going on six years strong and counting, pushing down on Treasury yields, spreads, mortgage rates, and pushing up on money supply. The result has been high bond prices, historically low rates, with the 10 year Treasury ending the year at 1.73% (below most inflation measures!), more “promises,” and a constant flow of new money into the markets.

The biggest beneficiary of all this Fed activity has been the stock market—which ended the year at some pretty good “handles,” with the Dow above 13,000, S&P 500 above 1,400, and the Nasdaq above 3,000. Price gains for the year ranged from just over 7% for the Dow to almost 16% for the Nasdaq. Stocks remain an attractive asset class with the dividend yield of 2.2% on the S&P 500 exceeding the yield on 10 year Treasuries of 1.73%. 

Housing markets have begun to improve with the national indices showing year-over-year growth of 3% to 4% recently. We have a long way to go before recapturing the home price highs of 2006 and 2007, but it is a start. Auto makers continue to enjoy their rebound, with the Big 3 US Automakers enjoying their best month in December, 2012 since the Great Recession took hold. Gas prices are finally coming down, making people able to drive their brand new cars more; I am glad to be testing the $3.00 per gallon price level rather than the $4.00 one.

The dominant theme of 2012 was the Presidential election. Over $2 billion was spent by both campaigns and nothing changed. I don’t know about you, but I want my money back! That $2 billion pales in comparison to JP Morgan’s losses of $6.2 billion so far from trading of credit derivatives by the London Whale. Boy, wasn’t Jamie Dimon humiliated when he found out it was more than a “tempest in a teapot!” 

Superstorm Sandy battered the coasts of New Jersey and New York with devastating results. Another of the year’s lows was watching our lawmakers and politicians argue until midnight on New Year’s Eve over the “fiscal cliff” and vote in the wee hours of the morning to “save” us. A new low, indeed, but more on that later.

The Fed—At It Again

The Federal Reserve keeps experimenting with their monetary policy moves, continually trying something new without waiting to see how the past moves are working out. In December, they announced that they would change their “promise” from keeping rates super low through the arbitrary date of mid-2015 to a “promise” to keep rates super low as long as unemployment exceeds 6.5% and core inflation between one and two years out is less than 2.5%, with inflationary expectations well anchored. So in effect, they have changed to a performance based measurement system that may not manipulate the yield curve as violently; this is clearly an improvement over the “pick-a-date” strategy. They could have included GDP growth as a benchmark; they will figure that out later and add it, I’m sure.

The Fed continues to buy bonds and more bonds. They announced another quantitative easing program—this time, QE3—part 2, in which they will buy $45 billion a month in Treasury bonds in addition to the $40 billion per month of mortgage backed securities that they are buying for QE3. Yes, folks, that would be $1 trillion per year! Since QE3 is open-ended, we have no idea how large it will grow. My thoughts are that, someday, they will want to sell the $2 to $3 trillion of bonds that they have accumulated in all of their QE programs. Nobody can buy that many bonds. Ben Bernanke probably does not have to worry about it; he has telegraphed his intention not to serve another term when his current one expires early in 2014. Who will bring Happiness then?

The “Fiscal Cliff”

Who in their right minds would have so many critical tax codes and laws expiring all on  the same year-end date? Oh, wait, our Congress! Once again, we saw the mad scramble to prevent a “crisis” and the secret meetings to get a deal done at the midnight hour. In the early morning of New Year’s Day, the Senate voted to pass legislation to make permanent most of the lower Bush tax rates, adjust deductions, extend unemployment benefits, continue tax credits and tax breaks, and, for some, just plain raise taxes. 

The stock markets rejoiced and rallied 2% to 3% on January 2nd, because the fiscal cliff was now manageable, not an apocalypse. Higher wage earners will see an increase in the top tax bracket, from 35% to 39.6%, and an increase in their capital gains and investment income levels from 15% to 20%. All workers will be impacted by the expiration of the payroll tax “holiday,” which means the Social Security tax goes from the temporary level of 4.2% to its original 6.2%, translating to an extra 2% tax to be paid in 2013 for 77% of households, costing them about $110 billion more in 2013 than 2012.

Aside from the secret negotiations and last minute crisis atmosphere that surrounds Washington DC, overall, it is a good thing that the cliff is resolved for now. The tax bracket changes become permanent and that will allow planning to resume. The estate tax exemption was raised to $5 million per individual. A permanent fix was placed into the tax code to index the AMT tax and save tens of millions of taxpayers from one of the more evil tax code provisions. 

The original estimates of the economic damage from the cliff were over $600 billion for the year in higher taxes. With the deal and the passage of the American Taxpayer Relief Act of 2012 on New Year’s day, the damage will “only” amount to about $160 billion (from the 2% rise in Social Security tax and higher taxes and capital gains/investment income on higher income taxpayers- $400,000 for individuals and $450,000 for couples). The estimated reduction to GDP would be -.3% to -.4% in 2013, rather than -1.2% for the whole cliff.

Spending cuts were not addressed in this latest deal. In fact, the sequestration cuts of $1.2 trillion over 10 years that were mandated to start on January 1st were postponed by two months. Isn’t that always the way? Spending will someday have its day of reckoning. We are currently at the debt ceiling limit of $16.4 trillion and the US deficits keep running at over $1 trillion per year, or about 8% of GDP. The debt of $16.4 trillion is well over 100% of our GDP, which should bring on more concern, especially as we watch our European friends deal with the same issues of too much spending and too much debt.

Finally, the IRS is warning that they may not be ready with the revised forms to address the new law in January. If forms are delayed until February at the earliest, there will be delays in filing and receiving tax refunds—you know, those interest free loans so many people grant the government each year. The average refund last year was $3,000, so spending early in the year may be weaker than we would normally expect.

Wrapping It Up

So, every year I talk about a Santa Claus rally. Did we have one? Yes, indeed; the S&P 500 was up 2.3% for the last five trading days of December plus the first two of January and the Dow was up 1.7%. Average Santa Claus rallies typically range from 1.5% to 1.7%. Happiness over the fiscal cliff deal made it happen, I’m sure, because all of the gain came on January 2nd. While there are still tax increases occurring in 2013, at least the deal made the impact a little more manageable. Stay tuned! 

Thanks for reading. DJ 01/04/13

Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy has been with First Federal of Bucks County since November, 2004.