One month into 2012 and the US equity market has kick-started what has been the best start to a year since 1997 – posting a return of almost 5% YTD on the S&P 500 as at 26 January 2012. The blue-chip stocks of the Dow Jones index have followed a similar trend rising by 4.23% while the tech stocks of the Nasdaq soared their way to a 7.68% YTD return over the same period. Positive sentiment has once again returned to the equity market with calls being made of a 1,400 closing level on the S&P 500 for the end of this year. Not to come across as the quintessential 'bear' (as you should ride the waves of the rally for as long as you can), but approach this optimism with caution, opting to read every headline that hits the market, so your year-end portfolio performance for 2012 does not come as a surprise to you.

On 25 January 2012 the market rallied to a one-month high of 1,326.05, the highest level on the S&P 500 seen since August 2011, on the news of the Fed's decision to maintain the benchmark rate between 0% and 0.25% until late 2014. The details of the report show that six of the seventeen Federal Open Market Committee participants projected a rate increase in 2012 and 2013, five projected an increase in 2014, and the remaining 6 anticipated a rate hike not until 2015 or later. This pledge of low rates came at a time of upbeat corporate results and stronger than expected US economic data which boosted the appetite for riskier assets. With inflation expected to remain low and rates kept lower for longer, the likelihood that the Fed will engage in a third round of quantitative easing has once again been brought to the forefront. Treasuries rose on this likelihood sending 10-year yields down to a 2-week low of 1.92% kindled by suggestions of a 'QE4' and 'QE5'.

Low yields do not bode well for lenders' profits who are already on the hunt for high yields on loans and securities to support their net interest margins by boosting investment returns. This reality hit the banking sector shares hardest as the industry's future profits was brought into question and led to a 0.57% fall day-on-day on the S&P 500 index on 26 January, exacerbated by an unexpected decline in new home sales.

While this daily decline appears marginal, the ease with which market sentiment can change should not go unnoticed. Admittedly market volatility is far from the levels seen in the second half of 2011 as reflected in the 60.8% drop in the VIX Index (this index reflects a market estimate of future volatility) from its one-year high in August 2011.

The question is, what caused this radical volatility in the second half of 2011? We should all know the answer to this no-brainer and now be asking ourselves, does this 60.8% drop in volatility mean that the eurozone debt crisis is a non-issue to the US equity markets? What has changed (if anything) in the eurozone to warrant little to no volatility in the market?

Almost every decision made and announced by the European authorities to manage its debt debacle during the second half of 2011 had a major impact on the market. Some may think the worst is over but the pressure still remains on Europe to do more to defeat its debt crisis. Four quadrants to the question "How will the euro crisis end?" have been highlighted. Either the euro survives or it collapses, there is either a good economic outcome or a bad one or a combination of each. We all hope for the best outcome for the euro, namely the euro's survival with a good economic outcome for the region. One should consider the possibility of a collapse of the euro currency and its likely repercussions. Such a possibility will continue to pressure the authorities to address the region's debt levels and restore confidence in the market.

In the interim, the optimism for the US economy is strongly reflected in the equity market which seems to be a stone's throw away from the 1,400 projection. With 11 more months to go in the year, we wait to see if the second half of 2012 resembles anything like that of 2011.

All information contained in this article has been obtained from sources that First Citizens Investment Services believes to be accurate and reliable. All opinions and estimates constitute the author's judgment as of the date of the article; however neither its accuracy and completeness nor the opinions based thereon are guaranteed. As such, no warranty, express or implied, as to the accuracy, timeliness or completeness of this article is given or made by First Citizens Investment Services in any form whatsoever.

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