A solid fourth quarter in the markets and in all Appleton Group Portfolios has set the stage for the New Year.  For much of the past three months there have existed sustained rising price trends for all market segments in which we invest, including U.S. equities (both dividend-paying and pure growth), emerging foreign markets, real estate, commodity-based equities, and high yielding fixed income. As a result, every one of our risk-managed portfolos advanced solidly in the quarter.

Click here for current short-term and long-term trendlines for all of the ETFs we use in our firm’s managed portfolios.

Over the past three months, the markets as a whole have responded positively to a variety of economic factors. These include rising job creation, solid corporate profits, and healthy economic expansion (especially overseas).  ADP (America’s largest payroll processing firm) announced this week that an estimated 297,000 new private sector jobs were created in December.  This reflects a significant jump from the 90,000 or so jobs that were created in the prior month.  In addition, the Institute for Supply Management reported that its index of service sector activity rose to 57.1 in December, up from 55 the previous month (any reading above 50 indicates growth). The increase marks the 12th straight month of expansion for the sector, which employs 80 percent of the U.S. work force.

While there still exist serious issues with several key european economies (such as Ireland, Portugal, Greece, and possibly Spain) the market volatility of last February and much of the summer appears to be of little concern to the markets right now. Confidence is everything, and there’s an improved sentiment among most investors that had been lacking for most of the past nine months.

Every fire needs fuel, and the current market advance has been fueled by the steady outflows from bonds and cash and into practically every growth segment of the market. Round after round of quantitative easing over the past two years (courtesy of the Federal Reserve) and the massive stimulus packages around the globe have kept interest rates low. But ever since November’s elections interest rates have begun to rise dramatically. Cause for concern? Not in the least, as it is merely evidence that investors who fled for the safety of bonds and cash can no longer stand the miniscule returns, no matter their level of safety (less demand for bonds means that interest rates have to go up to attract investors). This is a great indicator that the Fed’s goal of making it unattractive to invest in fixed income and money market assets may finally be gaining traction.

Looking Forward

Ever try to accellerate your car really fast on an icy road? If so, you know that you might simply spin your wheels for a time until they finally grab hold of the pavement. The same effect could easily happen to the economy, as for the better part of two years the Federal Reserve and the Treasury Department have done everything possible to get the U.S. economy going again. While the Fed has not yet seen the kind of inflation they had hoped for, Chairman Bernanke has stated bluntly that they will continue to “keep their foot on the accellerator” until it has the desired effect. This has been recognized by many as a high risk game of chance, burning through trillions of dollars of stimulus funds with little effect, until now.

If the U.S. economy does manage to find some traction (which would show up as a meaningful decline in the unemployment rate) the presence of eccess stimulus could jolt the markets further upward, largely as a result of expected inflation. And we’re already seeing the early signs of this effect. Oil is over $90 a barrel, gold is north of $1,300 an ounce, cotton and copper are both soaring, and food prices overseas are moving sharply higher.

Who wouldn’t like this scenario?  Well, China for one. A billion mouths to feed and the price of food rising sharply is a recipe for social unrest. India as well. And in Europe, powerhouse Germany has made it clear that they do not welcome the U.S.’s attempt to inflate their way out of economic trouble (see Weimar republic, late 1800s). For a time, modest inflation could be tolerated but the reaction from overseas will need to be watched carefully.

I invite your comments, and I promise a response…

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