Calendar year 2011 was very disappointing for investors.  If your portfolio mirrored the All Ordinaries Index, which it does not, it would have fallen in value by 15% during calendar 2011.

Instead, your portfolio fall in market value by ……….%, reflecting the diversification of your portfolio and an increased emphasis on cash and less volatile interest bearing securities that we have been recommending.

Nonetheless,  excessive day to day volatility in market prices, starting in mid-April and trending down for the rest of the year was disconcerting. In circumstances such as these,  we need to focus on the fundamentals of investing. 

Warren Buffett, the world most successful long term investor, and we add, amongst the most sane and wise investors, reminded us that stock markets can over-value stocks for long periods of time and can under-value stocks for long periods but eventually markets must correctly value stocks, based on their underlying fundamentals.

These fundamental are the income that they produce, their strength in the market, the quality of their management and their future prospects. Our view is that the stocks in your portfolio are very much undervalued based on the above fundamentals.

Quite separate from how the market values the stocks in your portfolio,  you have received interest payments, dividends and distributions during 2011 totaling $..........., plus franking credits of a further $ ………….which is a return of …..% of the current market value of your investment portfolio.

The Economic Outlook

In our mid 2011 reviews, we mentioned three emerging problems with the world economy that we called black clouds.   Of these, the solvency of  a number of European countries has proved to be the most destabilizing for investment markets.  These issues have had a punishing effect on investment markets world wide, but they have also galvanized European governments forcing them take action to stop the debt accumulation, to support the Euro and to effect a closer economic union.  We think that the most likely result of this crisis is that Europe will muddle through and that European trouble will be less of a drag on Australian markets in 2012 than they were in 2011.

We were concerned about the political impasse in the USA over whether the country would honor its debt obligations , about which a political compromise of sorts was found.   A new factor in the economic outlook is the strong recovery in the US economy that has been underway for some time. A range of indicators now show the a broad based  economic recovery is underway.  This can only be good for Australian securities markets.

Our concern about the durability of the China boom remains but does not seem to be an issue for the immediate outlook.

In summary, we are now more optimistic about the outlook than we were six months and twelve months ago.  We think that the patience that you have shown by staying invested in equities will be rewarded during 2012, but our level of confidence is not high enough to recommend that you move your asset allocation to favour higher levels of investments in equities. 

We will keep this situation under review.