The U.S. stock market, as measured by the S&P 500, ended virtually flat for the year of 2011 despite periods of extreme volatility. The Dow Jones Industrials, a narrower index, experienced 52 days of moves greater than up or down 1.5%, with 45 of them happening in the second six months. The year saw the Arab Spring, sovereign debt crises in Europe and the downgrading of the U.S. credit rating upon budget impasses. U.S. GDP likely rose a little below 2% in 2011. Inflation rose over 3% but interest rates remained low, making the 10 year U.S. government bond one of the best performing assets.

As we look into 2012, we believe U.S. GDP will grow 1.5 - 2.0%. U.S. Leading Economic Indicators have been steadily improving and the rate of growth of inflation is dropping, largely due to falling commodity prices. However, we expect Europe to be in mild recession and that will detract from U.S. growth. Headline inflation will fall to around 2% and interest rates will stay low as global easing continues. Countries around the world are faced with sovereign debt and budget crises, having to deal with massive entitlement program costs. In the long term those budget crises need to be faced and entitlement programs reformed (a politically challenging and perilous undertaking) since the current trajectory of budget deficits is unsustainable. In the short run, though, economies are facing the "paradox of thrift" - the right kind of stimulus is needed to spur economic growth.

We expect U.S. corporate profits to continue growing in 2012, though the rate of growth will slow from 2011. While the P/E multiple on the S&P 500 is low by historic standards, we do not expect P/E multiple expansion unless countries are seen making meaningful moves to manage budget imbalances and the global economy starts to recover. We therefore expect the U.S. market to be up in the low to mid single digits in the coming year.

Myriad risks remain. The global political environment remains volatile, particularly in the Middle East (and could impact world energy supplies). The U.S. is in a presidential election year with all its vagaries. While the Republican Party could win the Presidency and both Houses of Congress, Republicans have not proven themselves to be deficit hawks (based on the history of previous Administrations). Although decelerating Emerging Markets continue to grow at a faster rate than western economies, a hard landing in China would further derail a global recovery.