Grand Street Advisors 2013 Outlook

The markets put in a very respectable performance in 2012 catching most professional investors off guard and missing the move as 85% of hedge funds underperformed the S&P 500. Many spent much too much time looking for the black swan event that would send our economy reeling and markets swooning. It just never fully materialized. I guess we had many a tan swan though. There was the near Greek debt default. We were kept on the edge of our seats by the threat of a full scale bailout of Spain and Italy. The Middle East was set ablaze once again by rocket fire between Israel and the Palestinians as well as the raging ongoing civil war in Syria that has claimed over 100,000 lives. These events all paled in comparison to the paralyzing effect the juvenile politicking in DC had on the markets which severely hampered any progress on sculpting a credible budget deal. Who could really blame investors as they were in a position of the unknown. It's like going to a jump rope contest with a baseball bat and glove. You'll probably get a bunch of meaningless hits, but you won't win any double dutch trophies. Where We Are: The US economy has proven remarkably resilient in the face of uneven global growth and widespread fiscal uncertainty. Monetary policy has become the primary tool utilized to stimulate global growth and reflate assets these days in the face of social unrest and total political unwillingness to balance budgets and cut spending. < b>Retail Sales: December Retail Sales rose 4.8% after experienced a .6% swing in November from October's -.3% with notable strength in Automobiles which ended 2012 at a 15.5 million annual run rate. Building materials store sales were also robust rising 1.6% a direct beneficiary of the devastating storm, Hurricane Sandy. December's figures showed strength in high end Nordstom's, Macy's and also Costco. Laggards such as Target and Victoria's Secrets pointed to 24 hour fiscal cliff coverage damping consumer enthusiasm. Still many remained optimistic of a bump in sales post Christmas as those of us who weren't too naughty received gift cards that would send them scurrying to the mall to redeem. Inflation: The inflation rate for 2012 clocked in at a very tame 1.8% as measured by the consumer price index (CPI) a clear beneficiary of slack in employment, spare manufacturing capacity and rising productivity. One thing I'm growing more concerned about is how much these continued productivity gains are actually a result of the increase in the unofficial workweek. How many times have we all taken home some paperwork to catch up and how often have we checked and responded to "a few" emails? These are unreported and unpaid hours that cut away at our quality of life and as such cannot, will not and should not go on. That's for another discussion though. Industrial Production: Industrial Production staged a nice showing coming in at +1.1% a direct beneficiary from Hurricane Sandy. This disaster will benefit all major sectors of our economy for many quarters to come. Aside from the natural pent up demand that developed due to the recession over the years, Sandy's swells swamped and totaled thousands more automobiles that need to be replaced. Homes were leveled and businesses shuttered. Auto production popped 4.5% to end 2012 and should remain strong for 2013 as the general economy continues to heal. The housing industry already clearly in recovery will get an additional Sandy jolt which should help, building materials providers, appliance manufacturers and generally all ancillary industries with exposure to the sector. Hello GE, Home Depot and United Rentals. Good news for inflation hawks Factory Capacity Utilization rebounded .7% to 78.4 which still is 1.9% below its forty year average. Employment: We just received our first Non-Farm Payroll figures in 2013 with December coming in at +155,000 and the unemployment rate ticking up to 7.8% with the workweek +.1 and hourly earning up a not too shabby +.06. Good not great but enough to keep the trend in tact. I would anticipate a gradual acceleration in job creation after DC muddles through all the pre-posturing and threatening to finally forge a budget deal. Key drivers will be in automobiles manufacturing, health care and construction. If only Obama's EPA would embrace the energy sector and regulate "fracking" instead of threatening to outlaw the process we could see a surge in production, a spike in high paying jobs and along the way pushing us further towards our goal of energy independence. One can dream can't one? GDP: GDP most likely finished up 2012 at 2%-2.2%. Fairly lackluster considering we just closed out the fourth year after the recession ended in the summer of 2009. When we consider all monetary and stimulative programs from the Federal Reserve and D.C, it points to just how severe the recession was. 2013 should provide more of the same with weakness in the upfront month overcome with a re-acceleration in the back end of the year bringing growth to a estimated range of 2 1/4%-2 1/2%. This is of course all predicated upon DC doing the job they all were elected to do and not pushing us to the brink yet again. We are not overly confident this will be accomplished when we take into account this will be the third year in a row our fearless leaders have stale-mated us right up to the very last hour before reaching a deal. Monetary Policy: Domestic monetary policy will continue to be anchored at zero until the official unemployment rate hits 6 1/2%. This is the clearest sign ever from Federal Reserve policy makers. This clarity surrounding policy is very important when making long term investment decisions. Kudos to the Chairman for being so bold. The Federal Reserve's Quantitative Easing programs are not however tied to the employment figure. The Federal Reserve has sent a signal to the markets they will continue to purchase via QE, US Treasuries and Mortgage backed securities to help support housing and employment. The initial take was this program would go through 2013 and into 2014 at a minimum. We are not as confident the Fed will stay the course if we see continued progress in housing and the size of the Fed's balance sheet becomes problematic from the market participants perspective. For now it's steady as she goes with Bernanke's zero interest rate policy and monthly asset purchases of $85 billion which should continue to support markets along with the continued rebound in housing and construction. Black Swans: 1.An Inflation spike forces the Federal Reserve to reverse course sooner than stated causing a spike in borrowing costs and stymieing the housing and construction expansion sending markets reeling. This very real fear would be the result of years of printing money by all global central banks. 2. The failure of a major European financial institution reigniting fears of contagion sending the EU economy into a tailspin creating yet another drag on global growth. Many of Europe's large financial institutions still need to take write downs, sells assets and raise capital to shore up their balance sheets. Progress is being made, but the glacial pace needs to quicken. 3. Syria. In a last gasp move at preserving power Syria launches a preemptive attack on Israel causing a strong response. This may open the door for Syria's lone ally in the area Iran to enter the fray igniting the whole Middle East testing alliances and potentially dragging the US into yet another war with foes and allies uncertain. 4. Not so Black Swan: Washington continues to embarrass themselves in a spectacular show of ineptitude from both sides of the aisle not seen since the summer of 2011's debt ceiling debacle causing yet another credit downgrade investor uncertainty and sharp market correction. Going Forward: The US economy can and should do better as we get deeper into the new year. We simply need Washington to get out of the way. We look for exports to re-accelerate as Central Bank policy and stimulus programs in China, India, Brazil, Australia, Japan and Korea start to show meaningful traction. We also look for the EU periphery economies to begin a basing pattern as, ex-Greece most countries already have taken aggressive steps to right size government spending, pare back bloated government payrolls and liberalize private employment regulations. We look for continued progress in construction and housing as patient buyers are pulled off the sidelines with the looming threat of rising borrowing costs along with the pain of the recession falling further in the rear view mirror. We look for inflation to remain well contained in the 2%-2 1/4% range as commodity input prices come under pressure. We look for a rise in borrowing costs in the mid to late 2013 with mortgage rates climbing above 4% and 10 year treasury yields climbing to 2 1/2%-2 3/4% as the global growth story takes hold. Our year end target range for the S&P 500 is 1575-1620 which assumes earning of $105-$108 per share and utilizing a 15 multiple which implies a 10 1/2 % - 13 1/2% gain. In closing Americans needs a reality check when it comes to our perennial budget deficits and ballooning debt. There are some in Washington that would have us believe this can continue ad infinitum. This is clearly deceptive and outrageous much like the person that jumps from a 100 story building that believes he is flying right up to the time he hits the pavement. We as Americans need to ditch our party colors and encourage our elected officials to make the tough decision to cut spending, if not for ourselves for the children and future generations. That being said, as stated above we believe 2013 should be a very good year as long as DC gets out of the way. It therefore is a year where we don't believe we need to over complicate things. Keep our strong commitment to the market while buying good solid companies. As Warren Buffet stated long ago, " Invest in company's any idiot can run because eventually one will". We'll be on alert for any changes to Policy, in market sentiment or economic data that may change our view and be in contact to adjust our strategy and commitment to the markets. We thank you again for your patience and confidence in the very challenging times. Yours in pursuit of the KWAN.