Stocks shrugged off numerous worries to log a very good year in 2012. The riskiest areas were the most profitable. The bond side also saw riskier asset classes outearning traditionally safer fixed-income market sectors. Emerging-markets local-currency bonds notably gained 17%. Domestically, high-yield bonds and leveraged loans returned 15% and nearly 10%, respectfully, while investment-grade bonds returned 4%. Our active bond funds, in particular, added significant value versus the core bond benchmark over the last year.
Our expectation of slow economic growth has largely been right on over the past four years. Though there has been progress with deleveraging, the process is not nearly complete. And while the risk of another crisis has declined, it remains possible and is not easily dismissed.
A key risk going forward is how our politicians deal with the problem of growing public sector debt. The last-minute fiscal cliff compromise buys politicians a little time to address the more important longer-term fiscal issues, but does little to resolve them. Europe also made some progress in 2012, but most of that progress has been in the form of buying time by reducing borrowing costs.
The developed world continues to face significant debt-related challenges. The solutions are not easy and there are no quick fixes. Failure could play out in various ways, from another financial crisis to sharply higher inflation several years down the road. A brighter spot is that developing countries are generally less indebted and growing faster. However, growth has slowed there as well, partly due to the impact of reduced demand from the heavily indebted developed countries.
We recognize that there are a variety of bullish factors that could drive stocks to strong returns over the next five years. The odds of the bullish case playing out may be less unlikely than they were, but in our view they are still not high and it is more likely that we see a slow-growth environment with a continuation of aversion to risk.
Given continued risks and unsatisfactory return expectations for most asset classes across most of our scenarios, we are continuously researching and adding niche assets that we believe offer the potential to add value. This strategy requires the patience to wait for better opportunities.
As we look ahead, one thing we know is that there will be higher taxes on investment profits. As always we will continue to make our asset allocation decisions for taxable clients based on our assessment of where we can capture the best after-tax returns.
About the Independent Financial Advisor
Robert Pagliarini, PhD, CFP®, EA has helped clients across the United States manage, grow, and preserve their wealth for the past 25 years. His goal is to provide comprehensive financial, investment, and tax advice in a way that was honest and ethical. In addition, he is a CFP® Board Ambassador, one of only 50 in the country, and a real fiduciary. In his spare time, he writes personal finance books, finance articles for Forbes and develops email and video financial courses to help educate others. With decades of experience as a financial advisor, the media often calls on him for his expertise. Contact Robert today to learn more about his financial planning services.