December Market Commentary

* 60% All Country World Index/40% Barclays Aggregate

While Santa Claus didn't exactly deliver the rally that investors had hoped for, the S&P 500 did manage to post a gain in December, boosting the year-to-date return to a whopping +2.11%. Given the volatility experienced throughout much of 2011, this somehow feels like a win, especially versus other major markets that experienced double-digit losses for the year. Fixed income markets, however, experienced another solid year of returns as the Barclays Aggregate returned +7.84% for 2011.

Despite the low volume associated with the holiday season, the VIX did manage to hit a 5-month low during the month of December. This was a welcome respite for investors that have been inundated with market volatility during the past quarter. Whether this trend is sustainable remains to be seen. For now, the news out of Europe seems to have taken a back seat to the more positive domestic economic data that we have seen recently. This includes robust auto sales, declining jobless claims, improvements in the housing sector, rising consumer confidence and solid holiday retail sales.

Another notable development during the month was the weakness seen in gold and other precious metal prices. While we may simply be witnessing year-end profit taking from one of the strongest performers of 2011, it may also indicate waning fear of a systemic event associated with the European debt crisis.

As we enter 2012, it is interesting to note the difference in sentiment versus this time last year. Consensus estimates a year ago called for robust economic growth, rising bond yields and healthy gains for the equity markets. Of course, this was after a year in which the S&P 500 returned +15.06%, the majority of which occurred after the Fed-induced liquidity binge associated with the onset of QE2.

Having now ditched the rose colored glasses, expectations have taken a 180 degree turn, setting the stage for some positive market momentum should the negative sentiment prove overdone. The upcoming fourth quarter earnings season will provide the first insight into whether the recent economic momentum is translating into meaningful top-line growth. Recent improvements in the jobs data, coupled with emerging signs of life in the beleaguered housing market support the notion that there may be staying power to recent strength in economic activity. The ability of the domestic economy to break out of the recent malaise will be a key factor in driving equity market returns in the coming year.

While the outlook may be brightening domestically, the drag associated with the European debt crisis is much more difficult to handicap. Nonetheless, it will also be a key driver to market returns in the coming year. It appears that the recent liquidity provisions provided by the world's central banks have succeeded in calming markets as evidenced by declining bond yields across much of the Eurozone. In addition, tempered inflation expectations have allowed the ECB to cut short-term rates to a record low 1% with talk of more quantitative easing on the way. Whether these efforts can stave off a meaningful decline in economic activity remains to be seen, but the near-term prognosis suggests significant slowdown is in the offing.

The wildcard in global equities for 2012 is likely to be the emerging markets. Coming off of steep declines in 2011 driven by policymaker efforts to quell inflation, the table is set for a new round of easing, creating an interesting opportunity to ride a wave of renewed economic growth. Brazil has cut short-term rates three times, while China has also begun steps to unwind restrictive policy. Given the headwinds faced by many developed economies, the search for growth may very well be found in these emerging markets.

Clearly 2011 was a difficult year for equity investors, dominated by macro trends and heightened volatility. While it is too soon to tell whether or not we are heading in a new direction, at least expectations have been brought down substantially. This may set the stage for upside surprises, should the more dire economic predictions prove overly pessimistic.

This communication is not an offer or solicitation with respect to the purchase or sale of any security and is for informational purposes only. Information contained herein has been derived from sources believed to be reliable, but CAPROCK makes no representations as to its accuracy or completeness. Investment in securities involves the risk of loss. Past performance is no guarantee of future returns.