The market is up, but in an economy with high unemployment, a housing market in the beginning stages of recovery and a eurozone that remains volatile, the bull market of 2012 could quickly come to an end. Anything from a technical market correction to geopolitical concerns could derail what some economists believe to be a Fed-induced bull market.
2012 has been the year of the bull. With the S&P 500 up more than 12% in 2012, investors who have ignored short-term dips and held to a bullish strategy have done quite well. As the market has moved higher, an increasing amount of analysts have called for a market correction. Some believe that a short-term correction of 3 to 5% is imminent, while others predict that catalysts coming in the next couple of months could cause market turmoil.
If a large-scale correction were to occur, retail investors who have just recently returned to the market could again pull their money and miss the next move to the upside. Bank of America Merrill Lynch's head of U.S. Equity and Quantitative Strategy Savita Subramanian is calling for the S&P to reach 1,600 by the end of 2013.
Markets have enjoyed an impressive move to the upside, due in part to a stable eurozone. Although still volatile, the eurozone has received relatively little airtime in the financial media compared to recent years.
Spain, the eurozone's fourth-largest country, is now the country that investors are watching. In June, the country secured a $100 billion bailout for their banks, but the nation still faces a deep recession with high unemployment and a housing market that hasn't recovered.
The market has shrugged off much of the news from the eurozone in 2012, but investors still keep a watchful eye on the unfolding events and may be willing to sell en masse if an alarming headline hits the news wires.
Consumers spent more in the month of August, and while that should be good for the economy, getting past the headline reveals an ominous reason for the increase. Higher gas prices accounted for increased spending, while lower average wages in August made the headline more worrisome than optimistic.
Economists agree that the economy is growing but still faces significant risk if gas prices continue to rise or stay at levels at or near $4 per gallon for a sustained period.
Iran and Israel
Israel is worried about Iran. They're so worried that at a recent U.N. General Assembly meeting, Israeli Prime Minister Benjamin Netanyahu said that Iran would have the capability to build a functioning nuclear weapon by next summer. Iran said that if Israel were to attack, they would retaliate against Israeli and U.S. targets. Gen. Amir Ali Hajizadeh of Iran's aerospace division said that an attack would trigger World War III.
Any significant escalation of tensions between the two countries could trigger a stock market decline and military force would likely cause havoc on equities and commodities markets around the world.
The Fiscal Cliff
According to Reuters, if the fiscal cliff isn't averted, it could cut world earnings in half. The fiscal cliff is a combination of tax increases and spending cuts set to go into effect for 2013. If Congress fails to act, payroll, income and investment taxes are set to rise, unemployment benefits will fall and automatic budget cuts are set to take effect. In total, $607 billion will be slashed from the budget, but it would reduce U.S. growth by $800 billion.
The Bottom Line
The market may be up double digits in 2012, but significant near-term risks remain. Some market pros have reduced their exposure to protect against a market correction. Many of these events may not materialize, but retail traders with a shorter-term time horizon should have a hedging strategy to protect against these scenarios.