Economic releases portrayed firming of the U.S. and Asian economies, but these releases were not the driving force in the capital markets; that distinction belonged to the U.S. avoidance of the fiscal cliff, after which investors poured back into risk assets driving equity prices higher and credit spreads lower. In the first 3 days of 2013, Government bond markets fell as interest rates rose and the U.S. FOMC minutes disclosed debate over the timing of ending quantitative easing. The U.S. dollar rose against its European and Asian counterparts, but slipped against the Looney. Oil prices rose, but Natural Gas and Gold commodity prices fell in the first three days of the new year.

Perspective:

The New York Times reported that 2012 was one of eight years since 1928 when the S&P 500 never closed a day lower than the closing level of 2011; the last time that this occurred was 1979. For all of 2012 the S&P price rose 13.4 percent. Nice streak, but widely unnoticed! In spite of this positive performance, the continued uncertainty over budget issues kept the index from reaching into irrational exuberant levels.

In financial theory, stock prices are supported by earnings and expectations for earnings for the companies in the index. Based on historic earnings, the S&P 500 closed the year with a price-to-earnings (PE) ratio of 17; at the beginning of 2012 that ratio was just under 15. Using forward-looking earnings estimates from Birinyi Associates, it is now selling at 13 times projected earnings. When compared to the 140 year mean PE of 15.5 and median PE of 14.5, the S&P 500 appears to be fairly valued. In financial theory, stock prices are also supported by dividend payments made by companies in the index. The current dividend yield of 2.20 percent is 12 basis points higher than it was at the beginning of 2011. Both earnings and dividend statistics indicate the fair valuation of the S&P 500 Index.

Economic Releases:

The US Employment Report and the Purchasing Managers Surveys provided the first indications of economic activity for December. Those reports showed continuing firming of the US economy.

Non-farm Payrolls (blue in the chart at right) rose 155,000 in December; that release was in line with consensus, but October and November revisions netted another 14,000 gains. Private Payrolls (red in the chart) rose a better-than-expected 168,000; November Private payrolls were also revised 24,000 higher than their previous release. Manufacturing Payrolls (green in the chart below) posted a 25,000 gain in December. Not shown below, the Unemployment rate ticked up to 7.8 percent as more workers re-entered the market looking for jobs. The Average Hourly Earnings rose +0.3 percent and the Average Workweek increased a tick to 34.5 hours. In the last week of the year Initial Jobless Claims rose 10,000 to 372,000; the four week average of Claims rose to 360,000. Nonetheless, this was a solid Employment Report for the U.S.

The Purchasing Managers' Surveys in the U.S. also posted solid gains and finished the year above 50, the demarcation between expansion and contraction.  The Manufacturing Index (blue in the chart at right) rose a point to 50.7; the Services (red in the chart) rose over a point to 56.1.

In other PMI reports, China's Manufacturing PMI remained at 50.6 in December. The EU's Manufacturing Index slipped a tick to 46.1. Germany's Manufacturing PMI fell to 46.0. The UK's PMI Manufacturing Index crossed into the expansion zone, to 51.4; but, the UK's Services PMI crossed into the contraction zone, to 48.9. The Swiss Manufacturing increased a point to 49,5, but remained in the contraction zone.

Other Economic Releases:

November U.S. Factory Orders were flat in November. The minutes of the December FOMC meeting were released this week; those minutes revealed heavy debate about the continuation of quantitative easing with several suggesting that the bond purchase program should end at some point in 2013. The Canadian Unemployment Rate dropped a tick to 7.1 percent, while it added 39,800 to its Payrolls.

German Unemployment remained unchanged at 6.9 percent in December. German Retail Sales rose 1.2 percent in November, much stronger than expected. EU inflation remained contained at 2.2 percent year-over-year in December, matching expectations. German CPI rose +0.9 percent in December, but only 2.1 percent YOY.

Equities Markets:

Equity markets across the globe surged for the first three days of the new year in reaction to the legislation in the US that avoided the fiscal cliff. Bloomberg news reported that: when added to the anticipation of an agreement on the Monday prior to the votes, U.S. stocks had their biggest weekly gain (4.6 percent for the S&P, 3.8 percent for the Dow) in 13 months. The S&P 500 closing level was the highest since December 2007.

Bond Markets:

Government Bond markets fell as interest rates rose in reaction to the last minute agreement as well as better news on the economies of the US and Asia. Credit spreads narrowed, providing positive returns to the riskier credit markets despite the rising interest rates.

Currencies & Commodities:

The US dollar rose against the European and Asian currencies, but slipped against the Looney. Oil prices rose, but Gold and Natural Gas commodity prices fell in the first three days of the new year.

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Who is John Davidson?

John W. Davidson, CFA, started writing these Comments over a decade ago as a personal discipline when he was promoted to chief investment officer from portfolio manager.

Most recently, he was the president of PartnerRe Asset Management Corporation, responsible for the management of PartnerRe's invested assets, which grew from $4 billion to $12 billion during his tenure. After joining PartnerRe in the fall of 2001, he hired the staff, built the trading floor and created the infrastructure to manage both fixed income and equity assets internally. He retired from PartnerRe at the end of 2008 and moved to Maine.

He has more than 35 years of industry experience, including positions with investment management responsibility for separate institutional accounts, mutual funds, trusts, and insurance assets. Prior to joining PartnerRe, he served as president and chief executive officer of two other investment management companies. For various companies he has held positions as chief investment officer, chief economist, head of fixed income, and portfolio manager. As a portfolio manager, Davidson managed and traded U.S. Government Securities as well as futures and options on fixed income instruments.

His real world experience is backed by a strong academic foundation, which includes earning a Master of Business Administration in finance and a Master of Arts in mathematics from Boston College, as well as a Bachelor of Arts, cum laude, in economics from Amherst College. He holds the professional designation of chartered financial analyst.

His experiences and credentials have brought him to the public as a television commentator and conference speaker. In addition to his frequent past appearances on CNBC, CNNfn, Bloomberg TV and Yahoo FinanceVision, he has appeared as a special guest on Wall $treet Week with Louis Rukeyser. Reuters, Bloomberg and other business press services often quote his views on the market. He has taught CFA preparation programs, as well as other courses offered by the Stamford and Boston CFA Societies, and courses at the National Graduate Trust Officers' School.

Davidson is a natural leader in both his professional and personal life, having developed those skills early in his career as a Naval Officer. He spent three years on active duty, which included a year on the rivers of Vietnam, and 24 years in the Naval Reserves, from which he retired as a captain in 1994.

Davidson is treasurer and board member of the Camden Conference. He is treasurer of the Maine Conference of the United Church of Christ, serving on the executive committee and the coordinating council, the governing board of the conference. He is also on the investment committee of the Pen Bay Health Foundation.

In his leisure time, he is an active sailor, tennis player and skier. With his wife, Barbara, he renovated a 100+-year-old home in Camden, where they enjoy spending time with their two golden retrievers and having visits from their five children. He can be reached at jwdbond@me.com.