4Q Economic and Market Commentary
While 2011 can be characterized as a year when the economic news coming out of the US was largely irrelevant, as the world concentrated on the European sovereign debt issues that dominated the headlines, the fourth quarter of 2011 was dominated by the better than expected reports concerning US economic growth. The US equity markets responded to this with strong positive returns for the quarter, although that left the US markets barely ahead for the full year.
It appears that the US economy picked up steam at the end of the year, with most analysts predicting fourth quarter GDP growth was around 3%, the best quarter of the year. The private sector continued to add jobs, with over 200,000 added in December and 1.9 million added for the full year. The unemployment rate trended down during the year, declining to 8.5% in December from 9.4% in December 2010. Consumer sentiment improved for the fourth month in a row in December after bottoming out in August. Corporate profits continued to grow and are expected to reach record highs for 2011. Growth is anticipated to continue into 2012, although at a slower pace.
Europe continues to be a problem on the international front, as the debt issues have yet to be resolved, although an accord was reached in December that could at least address some of the issues. Meanwhile, the European economy is expected to experience a mild recession as the various restrictions that have been imposed on some countries take effect. In addition, China is experiencing a housing bubble as too much income is going into the housing market and home prices have risen to levels that many feel are unsustainable. With these and other problems, foreign stock markets did not fare well in 2011.
For the quarter, the S&P 500 rose 11.8%, offsetting losses earlier in the year and produced a very modest gain of 2.1% for the full year. Value stocks outperformed growth stocks for the quarter, but growth prevailed for the full year. Also, small cap stocks outperformed large cap for the quarter, but the opposite was true for the year. Foreign markets underperformed US markets in the fourth quarter and for the year, producing significant losses in 2011. In foreign markets, large cap and growth outperformed small cap and value. Emerging markets, which had been leaders for some time, suffered sharp declines for the year as concerns about their ability to sustain their high growth rates emerged. The continued appreciation of the US dollar against many foreign currencies added to the foreign losses.
Generally market trends in the US worked in favor of the Dimensional investment philosophy, while they worked against it in foreign markets. As a result, the Dimensional US equity funds used in the Elliott Cove Portfolios outperformed their benchmarks for the quarter, but they still trailed over the full year. Dimensional U.S. Large Company’s gain essentially equaled that of the S&P 500 Index for the quarter and year, at 11.9% and 2.1%, respectively. U.S. Large Cap Value benefited from its
overweight to energy stocks, which outperformed, and the fund posted a return of 13.8%, compared to the Russell 1000 Value Index return of 13.1%. For the last year the fund returned -3.1% versus the index return of 0.4%. U.S. Targeted Value with its small cap emphasis gained 17.3% for the quarter, although it lost -6.3% for the year compared to the Russell 2000 Value Index gain of 16.0% for the quarter and loss of -5.5% for the year. U.S. Vector, being a mix of large and small cap, value and growth, produced a return of 14.8% for the quarter and -4.6% for the year. In spite of the fourth quarter gains, US Large Company is the only domestic equity fund with a gain for the last year. This is due in part to the flight to quality and toward larger companies with higher dividends and in part to the overweight to financial stocks in the Dimensional value funds during a period when financial stocks underperformed the market.
While the foreign markets experienced gains for the quarter, they were much smaller than in the US markets and their losses for the full year were larger. With foreign value underperforming growth, Dimensional International Value underperformed Dimensional Large Cap International 3.1% vs. 4.5% for the quarter and -16.9% vs. -12.3% for the year, compared to the MSCI EAFE Index returns of 3.4% for the quarter and -11.7% for the year. Dimensional International Small Company underperformed large cap with a return of 1.2% for the quarter and -15.4% for the year. Dimensional Emerging Markets Value returned 3.6% for the quarter, but was the big loser for the year at -25.6%, as the sustainability of economic growth in the emerging countries continued to be a concern.
Dimensional Real Estate had a significant recovery for the quarter with a return of 15.1% and showed a gain of 9.0% for the full year. Longer-term interest rates on quality bonds showed a small decline in the fourth quarter producing a small gain for two of the fixed income funds for the quarter, while losses on foreign bonds resulted in two of the fixed income funds producing negative returns for the quarter. All showed gains for the full year. The Dimensional Intermediate Government Fixed Income fund gained 1.4% for the quarter and 9.4% for the year, while Dimensional Two-Year Global Fixed Income and One-Year Fixed-Income lost -0.08% and -0.04% for the quarter but gained 0.78% and 0.59% for the year respectively, as short-term interest rates remained extremely low. Short-Term Extended Quality came in between the other fixed income funds with gains of 0.1% and 2.9% for the quarter and year.
With all of the Dimensional equity funds producing positive results for the quarter, all of the Portfolios had positive returns for the period, with the most aggressive Portfolios showing the highest returns. However, with the negative returns of all but one of the Dimensional equity funds used in the Portfolios over the last year, only the most conservative Portfolios are showing positive returns for the year. Meanwhile, all the Portfolios still show positive returns over the last three years, with the most aggressive having the highest returns. The five year return numbers still reflect the equity Bear Market of 2008. Although there are times, such as the last year, when Dimensional’s approach will underperform the market, over longer periods, Dimensional’s investment philosophy has benefited the Portfolios.
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Past performance is no guarantee of future results. This information is provided for educational purposes only and should not be considered investment advice or a solicitation to buy or sell securities. Investments offered through Elliott Cove Capital Management are NOT insured by the FDIC, are NOT deposits of any bank, and may include risk including the possible loss of principal.