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"There is nothing wrong with America that faith, love of freedom, intelligence,and energy of her citizens cannot cure.”
- Dwight D. Eisenhower


Whew, what a year! If by some miracle you remained completely out of touch with the news headlines during the past year, you might assume it was an uneventful one with the S&P 500 essentially flat. Unfortunately, 2011 was a rollercoaster ride with ups and downs, and twist and turns, ultimately ending just where it began.

The Best House in a Bad Neighborhood

As we reflect on the past year and lackluster performance of the S&P 500, the US stock markets were actually one of the ‘least worst’ for investors, outperforming every other market index in dollar terms.[1] Many investors don’t realize that the S&P 500 has been outperforming the MSCI BRIC (Brazil, Russia, India, China) Index for four years now. To give some perspective, the table below shows the 2011 returns of 10 major International Stock indexes.

2011 International Stock Index Returns


The Chartist believes that the strong relative performance of the S&P 500 ETF versus other country ETFs is an indication the US will lead most of the world indices in the next bull market.[2] 
Richard Bernstein of Richard Bernstein Advisors notes that when Emerging Market Equities bottomed in 1998 they had free cash flow yields between 7% and 8% while US free cash flow yields were only 3%.[3] Today, it’s the opposite and a good indication for US investments.

Free Cash Flow Yields: 1998 vs. Today


Mr. Bernstein also believes that US earnings statistics remain the strongest in the world.[3] The graph below shows that US Corporate profits have already recovered and are making new highs. With the S&P 500 flat in 2011 and corporate earnings on the rise, valuations are now more attractive than this time last year.

After Tax Corporate Profits: Level and Yearly Change


Market Predictions… an exercise in futilityI

If the last few years have shown us anything, it’s that making predictions can be an exercise in futility. We will leave it to the ‘experts’. The table below shows the predictions of 10 Market Strategists from the December 19th issue of Barron’s. An average of the estimates calls for the S&P 500 to rise 8.5% to 1360 on earnings growth of 5% to 7% and a modest P/E multiple expansion to 13x from 12.5x currently.[1] These strategists acknowledge that there is significant upside and downside to their prognostications depending how the events in Europe continue to unfold. While we hope for the best, hope is not a way to manage risk. We remain focused on conservative managers in each asset class.

2012 Market Strategist's Forecast


According to Tobias Levkovich at Citibank, the spread between the S&P 500 earnings yield (8.6%) and the 10-year US Treasury yield (1.91%) is at a level that preceded big stock market rallies in the past.[1] He is cautiously optimistic on US stocks but does not see much upside for bonds.

10-Year US Treasury Yield vs. S&P 500 Earnings Yield


Given the ongoing global economic uncertainty, investors should expect continued volatility in the capital markets. Please contact us if you would like to discuss your risk tolerance or asset allocation.

A Word on Dividends

The total return of an investment includes two components: Income and Capital Appreciation. In the graph below, Bank of America Merrill Lynch US Equity and Quantitative Strategist, Savita Subramanian, shows that the S&P 500 dividend-payout ratio (the Income component) is at an all-time low.[1]

S&P 500 Dividend Payout Ratio


This aligns with our commentary last quarter which highlighted the large cash hoards on corporate balance sheets. It’s possible we could begin to see companies return this capital to shareholders in the form of increased dividends and share buybacks. For this reason, we’ve been making Equity Income investments like the Nuveen Santa Barbara Dividend Growth Fund (NSBRX). Manager, Jim Boothe, invests in companies that have a sustainable dividend and the ability to grow their dividend payout over time. Boothe generally avoids the highest yielding stocks, which have actually underperformed historically.

An update from Private Capital Management, Inc.

Earlier in the year PCM offered partnership to Justin Apt. He has over nine years of Investment Management experience working for several Registered Investment Advisors around the country. Justin’s background is primarily Investment Research and Trading, and his hard work has been instrumental to the firm. We are pleased to have him as part owner and Managing Partner. Justin is an additional resource for you, so please feel free to contact him with any questions or comments about your investments with PCM.

Sydney Williams of Monness, Crespi, Hardt & Co., Inc.

“My best advice for 2012 is to stay healthy and make the most of each day, keeping in mind that every hour that passes is one that is gone forever. Each one of us will have opportunities for success and for failure, and it pays to know the difference. It behooves us to be adaptable and accepting of change, the one constant in our lives. Life is a gift to be savored and enjoyed."[4]

Q4 and YTD Index Returns

[1] "2012 Outlook: Our pros see stocks rising 12%, after a rough first half. Buckle Up!” Vito J Racanelli, Barron’s 12/19/2011
[2] "The Chartist: Trendless Volatile Year” Dan Sullivan, Steve Mais 12/22/11
[3] "2012: Politics Versus Fundamentals” Richard Bernstein www.advisorperspectives.com 12/9/11
[4] "Thought of the Day: “Predictions – An Exercise in Futility” Sydney Williams, Monness, Crespi, Hardt & Co., Inc 12/30/2011

Disclosures
Investment Products: Not FDIC Insured – No Bank Guarantee – May Lose Value

Private Capital Management, Inc. (PCM) is a registered investment adviser. Opinions and information presented have been obtained or derived from sources we believe to be reliable, but we cannot guarantee their completeness or accuracy. Opinions represent PCM’s judgment as of the date of the report and are subject to change without notice. This material is for general information only and is not suitable for all investors. It is not soliciting any action from any particular investor. This presentation is not an offer to buy or sell, or a solicitation of an offer to buy or sell the securities mentioned. The investments discussed or recommended in this presentation may be unsuitable for some investors depending on their specific financial position and investment objectives. Private Capital Management and/or its personnel may trade for their own accounts, be on the opposite side of customer orders, and have positions in securities related to issues mentioned in this presentation. Investing in foreign securities presents certain risk that may not be present in domestic securities. Fixed income securities are subject to availability and market fluctuation. These securities may be worth less than the original cost upon redemption. Past performance does not indicate future results. The value or income associated with a security may fluctuate. There is always the potential for loss as well as gain. Asset allocation does not assure or guarantee better performance and cannot eliminate the risk of investment losses. PCM does not provide tax or legal advice. Please consult appropriate tax or legal advisors to determine how this information may apply to your own situation. The indices and benchmarks mentioned for comparison purposes are unmanaged. You cannot purchase an index. S&P 500 Index is an unmanaged capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy. The MSCI EAFE Index (Europe, Australasia, Far East) is a free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets consisting of 21 emerging market country indices. The Barclay’s U.S. Aggregate Bond Index is a broad-based benchmark that measures the investment grade, U.S. dollar-denominated, fixed-rate taxable bond market. The Dow Jones Commodity Index is an index composed of the futures contracts on 19 physical commodities. Additional information is available upon request. Dated: 12/31/2011
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