Post-’fiscal cliff,’ four themes to shape markets in the new year


As many investors had feared, the “fiscal cliff” drama in Washington is keeping Wall Street on edge as the year ends.

Word that no deal appeared imminent knocked the Dow Jones industrial average down 158.20 points, or 1.2%, to a one-month low of 12,938.11 on Friday.

But once the cliff is resolved — one way or another — four big economic and market stories of 2012 are likely to remain dominant themes of the new year.


The four:

• The housing market’s rebound. As recoveries go, the turnaround in housing this year doesn’t look like much on the charts, certainly not compared with the bubble years of the mid-2000s.

But the gains in home sales and prices in 2012 were critical for underpinning confidence that the U.S. economic recovery had legs. To think of it another way, if the housing market had continued to sink, it could have done severe damage to consumer confidence, the banking system and the stock market.

New home sales reached an annual rate of 377,000 in November, the best pace since the brief spike to 422,000 in April 2010, the government said this week.

The 2010 jump was a one-off, fueled by the expiration of a special tax credit for buyers. This time around sales have been climbing slowly but steadily from an annual pace of 292,000 in August 2011, helped by record-low mortgage rates.

Wall Street seems convinced that the housing depression is over for good: An index of 11 major builder stocks has rocketed 80% this year to the highest since mid-2007.

Quiz: How much do you know about the “fiscal cliff?”


In another sign of sustained progress, the Standard & Poor’s/Case-Shiller index of home prices in 20 major U.S. cities was up 6.9% year-to-date through October, on pace for the first annual increase since 2006.

There’s still a long way to go to recoup the trillions of dollars in home equity that was lost in the housing bust. The S&P;/Case-Shiller price index remains 29% below its record high reached in July 2006.

But market trends, bullish or bearish, often feed on themselves: If people believe that home prices have bottomed it removes a key psychological roadblock to the idea of trading up, or buying for the first time.

Michael Darda, chief market strategist at MKM Partners in Stamford, Conn., expects home prices to continue to rebound with demand. “With the [Federal Reserve] easing, this could create a self-reinforcing dynamic as household balance sheets improve and banks become healthier,” he said.

• Central banks double down. Since the financial crisis began in late-2008, the world’s major central banks have slashed interest rates to try to prop up the punch-drunk global economy. This year, worried that growth remains tenuous, the banks amped-up their support, ignoring critics who say they have set the scene for the next financial-system nightmare.

The People’s Bank of China trimmed rates again in 2012 and freed up commercial banks to lend more. Australia’s central bank cut its key rate four times to a three-year low. In September, the European Central Bank pleasantly shocked markets by announcing that it would buy unlimited sums of struggling Eurozone countries’ bonds, if necessary, to push long-term interest rates lower.


“In addition to the Fed, other central banks did their utmost to reduce the danger of a global relapse,” said John Lonski, chief economist at Moody’s Capital Markets Research in New York.

This month, the Federal Reserve went a step further, saying it wouldn’t stop trying to keep interest rates at rock bottom until the U.S. unemployment rate fell to 6.5% from the current 7.7%.

Next up: Japan’s new prime minister, Shinzo Abe, has called on the Bank of Japan to provide “unlimited” monetary stimulus until the country’s long-suffering economy revives convincingly.

The banks’ harshest critics say the continuing flood of easy money will eventually result in catastrophic inflation and the collapse of paper currencies. But central bankers argue that they must keep credit extraordinarily cheap in the face of weak consumer and business spending and government austerity.

While obviously aware of inflation risk, policymakers have decided to take Scarlett O’Hara’s approach: “I’ll think about that tomorrow.”

• “Yield desperation” deepens. For investors and savers, a major downside of central banks’ ultra-low-interest-rate policies since 2008 has been a dwindling number of investments that pay decent interest income. That situation got much worse this year.


Weak economic growth and the Fed’s continued massive purchases of longer-term U.S. Treasury bonds drove the 10-year T-note yield to a generational low of 1.39% in late July. It has since rebounded to 1.70%, but that’s still just half what the yield was in early 2011.

With Treasury rates so minuscule, many individual and institutional investors rushed to buy corporate bonds, including junk issues — bonds rated less than “investment grade.” Soaring demand for corporate debt drove those yields to generational lows too.

Just this week the average junk bond yield hit an all-time low of 5.66%, according to KDP Investment Advisors. At the peak of the 2008 financial crisis the average junk yield was a whopping 17.7%.

As with U.S. bond yields, ravenous investor demand this year pulled down yields on bonds of many emerging-market countries including Turkey, Russia and the Philippines. Even in Greece, the epicenter of Europe’s debt crisis, the market yield on 10-year government bonds has tumbled to under 12% from more than 30% in May.

Quiz: How much do you know about business news in 2012?

As they accept ever-lower yields, investors face two major risks. One is that they’re handing money to governments or companies that will have trouble paying them back in full. Europe’s debt woes, after all, still loom large.


The second risk is that market interest rates could rebound, devaluing older bonds issued at lower fixed rates.

Well-known hedge fund manager Kyle Bass has made a widely publicized bet that the first significant investor revolt against ultra-low rates will come in deeply indebted Japan.

Bass’ bet has been a disaster so far: The 10-year Japanese government bond yield hit a 2012 low of 0.69% on Dec. 6. It has since rebounded to 0.79% as Japan’s new government has pledged to launch another round of massive stimulus programs.

• The return of the dividend. Faced with an investing public that has largely turned away from equities, many U.S. companies are trying to attract buyers to their shares with an Eisenhower-era strategy: the promise of cash back.

Companies in the Standard & Poor’s 500 index are on track to pay $281 billion in regular dividends to shareholders this year, according to Howard Silverblatt, senior index analyst at S&P; in New York. That would be a record for any year and a 17% increase from 2011.

In addition, billions of dollars more are flowing to shareholders in special year-end dividends announced in recent weeks by hundreds of companies, including retailer Costco Wholesale, truck maker Paccar Inc. and financial services firm T. Rowe Price Group.


In part, corporations are just sharing their bounty: Soaring corporate earnings since 2009 have left the S&P; 500 firms with a record $1.03 trillion in cash on their balance sheets, S&P; calculates.

But executives also grasp that they need to offer more than just the hope of share-price appreciation to draw investors to their stocks, market pros say. Dividends are the proverbial bird in the hand.

“Investors are pushing for return of capital in a low-return environment,” said Barry Knapp, chief equity strategist at Barclays Capital in New York.

Stock dividend yields (annual dividend payment divided by share price) still are far below the 4%-plus average that investors enjoyed in the 1950s. Still, at 2.3%, the S&P; 500 average yield is well above the 1.70% yield on 10-year U.S. Treasury notes.

More important, dividends can grow over time, unlike bond interest that is fixed for the life of the security. Even if dividend tax rates rise for some or all investors as part of a fiscal cliff deal, the prospect of dividend growth ought to be a powerful lure for many income-hungry investors.

Silverblatt predicts a new high for dividend payments to shareholders in 2013 “regardless of what Congress does or does not do.”