With 2011 coming to an official end (with a whimper) and 2012 just getting started we thought it would be appropriate to round out our theme of 5 Things You Need to Know for 2012 that we began discussing back in October. It’s always fun and often humbling to look back at what has been prognosticated in these writings and update them in real time. To bring any new readers up to date, we decided back in October to come up with 5 themes we could watch throughout 2012. We wanted concepts that were both entertaining and useful for your investment portfolio with a bit of a contrarian twist to them.
Before we jump into our themes I think it is important that all readers understand that these themes are framed within the belief that the equity markets are in the early phases of a larger topping process. If we are correct on this then the equity markets will not be able to move above the highs seen in 2011which are only a few percentage points above where we are now. There is always risk in making a market call like this. However, in this case I like the risks we are taking.
If we are wrong and the market is able to move above the 2011 highs we have only lost a few percentage points of opportunity before we will have to admit to being wrong and create a new thesis. However, if we are right and the market declines into some of our lower target prices the amount of money saved will give us a lot of dry powder to take advantage of opportunities. If you’re interested in the research that has lead us to this conclusion contact us or join us at our next lunch and learn. With that disclosure let’s get started with 5 Things You Need to Know for 2012.
1. It’s Never Official until it’s 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
The idea for this theme was born from an interview of Timothy Geithner in which he assured Jim Cramer on CNBC that there would not be a “Lehman Bros. situation” in Europe.
Since that interview back in September of 2011, we are happy to report that there has not been a Lehman Bros situation in Europe. However, there was the melt down of MF Global, an agreement for creditors of Greek debt to accept half of what is owed to them as well as a global coordinated effort of central banks to provide dollars for the cash strapped financial organizations in Europe. The reality is the Euro Zone has very few choices in solving their debt issues. 1. Dismantle or reorganize the Euro 2. Reduce Spending or 3. Continue to kick the can down the road…….all of which appear to be negative to economic growth.
2. Volatility is here to Stay, Make it Your Friend
2011 was an unprecedented year with the S & P 500 having more triple digit moves in both directions than any other year that I can recall in the past 15 years.
The reasons for this volatility are too numerous to cover in this letter.
Know this, since our last writing the volatility has continued and by our estimates will continue throughout 2012.
For this reason we have been encouraging all investors to stress test their portfolios against potential market declines to get a feel of what they could experience if this volatility were to create a downward trend in markets. In addition to stress tests, diversifying your portfolio into alternative asset classes that may have less correlation to equity markets should be considered depending upon your time horizon and risk appetite.
This as well as how to determine your time horizon and risk tolerance is something we cover in depth at many of our workshops and encourage you attend to learn more.
3. Remember the Grieving Process and Try Like Hell to 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. Here is a visual for you.
How does one avoid this? Sir John Templeton stated it best with “When others are greedy you should be fearful and when others are fearful you should be greedy”.
Simply put, you want to avoid being sucked in by the media and buying at the highs. You make your money when you buy and if you can avoid the temptation of buying when markets are topping you will be taking the first step in avoiding the grieving process.
At Quiver we like to use sentiment indicators as one of our tools to help us with this. Sentiment indicators give us an idea of how bullish or bearish both retail and/or institutional investors are about the stock market.
It is very common for market tops to be associated with elevated levels of optimism by retail investors. Currently those indicators provided by AAII are at levels where we have experienced previous market tops. Something to consider as investors contemplate that New Year’s investment.
4. The Dollar Matters
The US Dollar can have a dramatic effect on your portfolio. For this reason I encourage you to go back to our October letter where we lay out 3 reasons the dollar matters. I’ll reiterate what I think is the most important point made in that letter about the 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.
In addition to this commentary from our October version of 5 Things for 2012 I offer this visual of the US Dollar vs. 6 other major currencies over the past 5 years from Bigcharts.
The things to be aware of on this graph are: 1. The long term support line. As long as this exchange traded fund which represents the price of the dollar versus 6 other currencies remains above this support shelf (near 22) I would expect it to remain in a bullish phase. The fact this support line is fairly close to current prices makes for an appealing risk reward profile depending upon your time frame.
2. Note how the US Dollar gained strength into the stock market bottom of 2009. If our prediction noted in the first paragraph is true we would expect the dollar to continue to gain strength as the stock market weakens. The opposite could hold true and this why it nice to be able to define our risk using the support line as a stop loss.
3. Both MACD and Relative Strength which are technical indicators are trending higher. 2012 could be a very interesting year for King Dollar, one all investors should pay close attention to and should stress test their portfolio against to get a feel of how a stronger vs. weaker dollar may influence the rest of the portfolio.
5. The Seeds of Opportunity are often found within Creative Destruction
In 1913 German sociologist Werner Sombart coined the term Creative Destruction in his work “War and Capitalism”. The idea was to describe the way in which the capitalist economic development arises out of the destruction of some prior economic order.
In short, just like new life grows from the ashes of a forest fire the same happens in business and economics.
For the past 30 years decreasing interest rates have helped fuel the growing debt bubble that the world is now choking on. We now sit at historic cross roads.
Both households and sovereigns have reached their debt limits and have been either reorganizing their debt (default) or cutting costs and increasing savings in order to service the existing debt. Both scenarios will continue to be a drag on future growth which will eventually force the weak hands to say “uncle” opening the door for new creation.
The seeds have been planted and every time the powers to be kick the can down the road they are watering the creative destruction process that should serve prudent investors well over the next few years. The process of getting there will be tricky but with the right tools in your quiver many opportunities will arise.
Until next time, have a Happy New Year.
Newport Coast Asset Management
The opinions expressed are those of Colby Mcfadden and Quiver Financial as of January 3, 2012 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.