With the year of 2011 rounding third base and times looking less clear than most people would like, we felt it was an appropriate time to step back and think about the upcoming year and focus on a handful of items that could quite possibly be game-changers for your investment portfolio.
Our effort here is to look at subject matter that may not be on the front headlines of major news providers but are definitely having some effect on your pocket book.
So let’s get started with the first theme.
It’s never official until it’s officially denied
As we maneuver through the next phase of this financial crisis I offer the cynical view that it is never official until it is officially denied.
Whether it will be Greece denying bankruptcy or Treasury Secretary Geihtner saying their won’t be a Lehman Bros. situation in Europe, know this…the moment someone in a role of authority states that something is definitely off the table, you better assume the position.
To help put this in context I offer you the following famous quotes provided by Todd Harrison of Minyanville.
“Dewey Defeats Truman” Chicago Daily Tribune 1948
“The Subprime Problems are Contained” Ben Bernanke 2007
“Mission Accomplished” George Bush referring Iraq 2003
“Passengers safely moved as Titanic is taken in tow” Christian Science Monitor 1912
“I am convinced we have passed the worst and with effort we shall rapidly recover”Herbert Hoover 1930
“We will not have any more crashes in our time” John Maynard Keynes 1927 (2 years prior to the great crash)
“The water is great come on in” Christie Watkins in the movie Jaws
“There is nothing in the situation to be disturbed about” Secretary of the Treasury Andrew Mellon prior to the Depression 1930
Volatility is here to stay…
Make it your Friend
I would love to invest countless pages telling you about all the multiple crossroads that are intersecting at one time in history, but I think most readers of our writings are quite aware of the obstacles that exist in today’s world.
a href=”http://quiverfinancial.com/jul2011.html”>Making chaos and crisis your friend is an art form we like to play with here at Quiver. In that spirit we offer you the contrarian thought that opportunities exist in this market and many more opportunities are going to be showing themselves in the near term time frame.
We are in the midst of some exciting times, and with exciting times comes volatility.
The bottom line is everything in life is moving faster and this is not a trend that looks like it is going to stop anytime soon.
As information travels more efficiently, markets will react faster to events, both good and bad. The blending of art and science that goes into the design of an investment portfolio will have the greatest effect on potential returns over the next 3 years. Being that this is right in our wheel house we offer this over simplified three step process to diversification that may help you tame the market’s volatility. This is by no means meant to be a one-all recipe but you’ll get the basic idea.
The first step is to understand the time frame in which your hard earned money is going to be invested. The investment strategy you pull from your quiver when investing for 1-2 years is completely different than the arrow you will use to hit your target when investing for ten or more years.
Defining the proper time frame is crucial in lining up the probabilities of successful investing.
Transitioning to step 2 is the process of examining and determining the macro trend of the economy and financial markets. Essentially, this is where you determine whether we are in a bull or bear market. Not always an easy task but with the proper research this can be done. This step helps define the risk that should be applied within the portfolio.
In step 3 the view point gets narrowed down and a comparison of relative strength and correlation of different asset classes is performed. In addition to this a forward projection of possible events should be taken into consideration. For example 2012 is an election year which will have effects on shorter term moves within the market. This narrowing-of-focus helps lead you to the final diversification of which assets may help you accomplish your goals. Heck, you may even find some joy in the process knowing there is a way to accomplish what you need.
We can’t emphasize enough the importance of investing extra attention to the correlation of each investment in your portfolio. The goal during 2012 should be to have low correlation to the volatility of financial markets and with the recent expansion of Exchange Traded Funds this can be done in many different ways but the process starts with you getting your portfolio tested.
Correlation is the most over looked structural component when portfolios get designed by individual investors and unfortunately by many financial advisors as well.
Remember the Grieving Process and Avoid it
It is widely accepted that grieving arrives in 5 stages: denial, anger, bargaining, sadness, and acceptance. If we apply that psychological continuum to our portfolios, it offers a valuable lens with which to view the evolving financial crisis.
This portion of today’s missive is specifically targeted to the people opening their September Investment Statements with a sense of shock due to the change in value and may start thinking …. “it’s ok, the market always recovers….look what happened after the lows of 2009.”
For those thoughts I offer you the fine river in Egypt called DENIAL. While I don’t claim to predict the future I do pride myself on being an astute student of markets and economics and offer this one simple fact.
Yes, markets recover….but in what time frame?
The reality is, when we entered into the financial crisis in 2007 the US was approximately 35% percent debt to GDP, according to Bloomberg. The government had a lot of room on its credit card to take some cash advances to help recapitalize the economy and fuel the recovery of the past 2 years.
Now it is a different story with our debt to GDP now at roughly 100%. The credit card is maxed out and our country is going to have to make some very difficult decisions over the next year.
With each difficult decision there is the chance we will see a reduction in growth as you can’t reduce spending without having a negative effect on growth.
Keep that at the forefront of your mind as you look over your recent statements and know that inaction will only float you down that river to the next port of Anger when you declare “Darn it I knew I should have sold that dog”.
Being proactive will be your biggest advocate in preventing you from arriving at the all famous river village of Ostrich Ville where you can find countless investors “Bargaining” with their head in the sand mumbling “ well it’s too late now, I have already lost so much what can I do?”
Mark my words there are better ways than this river boat of pain and it starts with a good look at the risks associated with your investments and how they are all correlated.
The Dollar Matters
With almost all assets being correlated during liquidity events it is important to be aware of the assets that may play a silent yet powerful role within the financial system.
Often times the US dollar does not get enough attention when investors and financial advisors are designing their allocations.
The first thing to understand is that the US stock market loves a weak dollar.
There are many reasons for this but the first is the fact that most companies listed on the US indexes are multinational companies which generate a large amount of revenue from overseas. A weak dollar helps these multinational companies boost earnings through the exchange rate difference and other accounting and tax methods.
The next main reason the US Dollar matters is what is called the “carry trade” which is a bit difficult to go into details with the limited space I am giving myself in this letter.
The reader’s digest version is that a carry trade is when a financial organization borrows money in one currency and loans in another. The spread between the 2 currencies is profit and a weakening dollar creates a tail wind to this trade. With a stronger dollar these trades need to be unwound which brings additional buyers to the dollar.
The third and probably most misunderstood fact is the effect sovereign debt has on The US Dollar.
It’s no secret that Greece, Italy, Ireland, Portugal and Spain are in deep doo-doo (technical economic term) as their debt levels are unsustainable. The end result or what John Mauldin has termed the “End Game” is that all of these countries will need to restructure this debt which in essence is debt destruction.
The mechanism behind this has huge ramifications to the price of the dollar and in return to other financial assets.
Follow me on this. As dollar-denominated debt is extinguished – through payoff, reorganization or bankruptcy – remaining dollars become more valuable. Pushing the demand and price of The US Dollar higher. This will have profound implications for not only the stock market but commodities as well. Understanding how this will affect your portfolio and making adjustments accordingly is a must if you want to have a chance of prospering in 2012.
The Seeds of Great Opportunity are often found within creative destruction.
Creative destruction describes the way in which capitalism evolves out of the destruction of some prior economic order. In nature this is seen when new growth is fertilized by the ashes of a forest fire.
In our current financial system I would not be surprised to see an onslaught of creative destruction as sovereigns across the world will accept the fact that they are never going to get paid the money owed to them. How this process will be handled is yet to be seen and will most likely open the door to many opportunities as larger organizations are dismantled. The plus side to this is that the weaker parts of these companies will fall into the hands of more capable more motivated people and the seeds of new business will begin to sprout.
Here at Quiver we are more optimistic about the next 5 years than we have been in a very long time. We believe the path over the next five years will be marked with some challenging times in the shorter 6 to 18 month time frame.
However, these times are what will pave the way for the more astute investor that has managed their risk well to be able to buy many assets at bargain basement pricing. This should be very exciting for investors with a time horizon of 5 or more years.
It’s time to hit the send button but before I do I would like to invite you to get a deeper understanding of The 5 Things You Need to Know in 2012 by joining us for lunch on Thursday October 27th in Irvine, Ca where we will discuss in detail the steps you can employ within your portfolio to possibly get ahead of the curve in 2012.
In addition to that, keep your eyes peeled for our next newsletter The Five Pillars Of Financial Markets where we discuss the investment opportunities in Gold, Oil, Stocks, Interest Rates and The US Dollar.
Newport Coast Asset Management
The opinions expressed are those of Colby Mcfadden and Quiver Financial as of October 6, 2011 and are subject to change due to market or other conditions. This is not a solicitation or recommendation of any investment; always consult a Financial Advisor before investing into any investment. Securities offered through Newport Coast Securities member FINRA/SIPC. Advisory services offered through Newport Coast Securities a SEC registered investment advisory.