5 Things You Need to Know for 2012: The Bull Case

In 1850 Federick Bastiat, a French theorist and political economist, introduced the concept of “opportunity cost” in his essay “What is Seen and What is Unseen”.

It was written as a parable discussing the seen and unseen economic impacts which occur when a shopkeeper’s window is broken. On the surface the misfortune of the shop keeper seems obvious as being the negative impact on the shopkeeper’s pocket book as he must pay to have the window fixed not to mention the loss of revenue if he should happen to close for a day to do the repairs.

These surface events are the seen and lying beneath the surface is the unseen represented by the lost pay of the employees for that closed day and how that ripples through their lives, or the positive results the glass glazer receives by the shop keepers recent brush with poor luck as he gains revenue and profits in the selling and installation of a new window.

The representation of the parable is that with every seen result there is a series of unseen results which can have equal to greater effects. Some may call this “Unintended consequences”, for Bastia’s work it became known as “opportunity cost”.

Opportunity cost is something we brought to light back in October and January when we covered the 5 Things You Need to Know for 2012 from the bearish perspective.

Now after a strong start to the year for equity markets it’s time to give some attention to the Bovines out there and explore the Bull’s case for the possibility of higher markets throughout 2012.

The goal is for you to have an understanding of two possible scenarios for financial markets.

One focused on the possibilities of lower markets such as we discussed in previous months and the other focused on the possibilities of higher markets over the course of the next 12 months.

We hope readers will use these two scenarios to gain a greater understanding of the potential risks and rewards we see in markets.

Hopefully you will be able to use this information to help you create a portfolio that is appropriate for you.

So with no further delay let’s get started.

The Bulls Tale For 2012
In our previous writings we gave you a number of fundamental and technical reasons why being cautious in the near term (3mo to 1yr) was warranted. I would encourage you to review those writings if you haven’t already.

For today’s scribing we will start with one of the larger fundamental overhangs that spooked investors in mid 2011 and caused markets to decline as much as 15% from their April (measured by the S&P500) highs as the European Debt Crisis hit a crescendo moment.

Now after an impressive rally to the upside since mid December it appears through the view of fund flows provided by firms like Trim Tab that the European debt issues may have been a positive to U.S. Equities helping the Dow and S&P push higher to just under those old 2011 highs which represent the KO level for our previous bearish discussions.

You may recall we said as long as the equity markets remain below their 2011 highs the Bears still had the upper hand.

With those Bear KO levels only points away we should know fairly soon if the flow of funds from European investors, as they move their money out of Europe to safer markets like the U.S., has enough strength to continue to push US markets higher.

A break above the 2011 highs with increasing buying volume and breadth will be the next tell.

If that is an event to be seen in the future then I would expect investors that may have missed out on buying in November and December decide to capitulate and become buyers as the pain of opportunity cost becomes too great.

Considering we are only points away from a level that represents the trigger point for risk on or risk off all we can do is wait and observe to let the market tell us what its intentions are. As soon as we see any signs that lead us to be buyers or sellers we will update you in future writings.

Election Years and Your Money
Historical data from publications like “The Stock Traders’ Almanac” as well as various studies by many institutions have shown that election years have a tendency to favor the Bulls. So we decided to check this claim out for ourselves by searching the internet and creating a chart which contains the election year in one column and the return of the S&P500 in that year in the adjoining column.

Using this data from 1968 to 2008 would seem to confirm that election years benefit the bulls. After all, since 1968 there have only been 2 out of 13 years that the S&P 500 was in the red.

Will 2012 be a repeat?

Time will tell and one thing can be bet on. The Obama administration will do all that is within their power to get confidence levels as high as possible going into September.

Expect to see numerous announcements of policies designed to support housing and the consumer to make sure their poll numbers are strong going into September which leads us to our next theme.

The Obama Halo Effect
Listening to Mr. Obama’s State of The Union will give you some insight on what industries you may or may not want to lean your investments towards.

In case you missed Mr. Obama’s State of The Union address you can catch it here.

To save you some time and energy we have listed the industries that may see a benefit by an Obama reelection as well as those that may want to watch their back. For sake of time we can’t cover each industry in today’s rant.

However if you are interested in how to include or exclude one of these industries from your portfolio you are always welcome to give us a call.

Obama Winners
Alternative Energy
Housing
Small Caps and Start Ups
Information Technology
Basic Materials and Infrastructure
Metals/Commodities
U.S. Manufacturing

Obama Challenged
Big Oil
Financials
Defense

One of the more significant Obama Halo effects that will most likely be seen in 2012 will be within the housing market.

With new policies giving underwater homeowners the ability to refinance to lower rates will help those homeowners lower their costs with the end result being extra cash flow that is able to find its way back into the economy via your local Apple store.

“Don’t Fight the Fed” May Make You More than You Think
It has long been said that a smart investor doesn’t fight the fed and there have been numerous past experiences that would seem to support the belief. 2012 may be the year where this term gets broadened to “Don’t Fight the Central Banks of The World”.

The Fed has made it clear that they intend to keep interest rates at or close to current levels for as long as they can or at least until 2014, which is an extension to their previous commitment to keep rates low until 2013.

The recent extension of this low rate commitment has raised the voices of contrarians as they question, if the recovery we hear about in the economy is doing so well, why the extension of one more year?

None the less the Fed has committed to low rates and as long as the European debt issues are more concerning than US debt issues we should continue to expect the benefits associated with low rates.

Combine that with Europe’s recent commitment to liquidity facilities designed to provide funding to banks at near 0% rates which allows the banks to then turn and buy government debt earning 5% +, giving them a nice profitable spread or “Carry Trade”.

Not to mention how the circle of cheap government loans to banks finds money flowing back to the purchase of government bonds right at the moment governments need as many buyers as possible to fund their debt obligations.

This under cover QE provides additional liquidity which usually would find its way to riskier assets such as Stocks and High Yield bonds.

The bottom line is that central banks around the world are taking their turn in opening and closing the liquidity spigots in a coordinated dance which will continue to have influence on currency markets and most likely increase the volatility of all markets as this liquidity ebbs and flows.

Proper diversification and testing your portfolio for “Upside vs. Downside Capture” will be one of your strongest tools in managing future volatility.

You can learn more on how to do this by coming to our next Lunch and Learn on February 15th.

Earnings
Since the market lows in March of 2009 corporate earnings have gone through a significant metamorphous.

When an economy goes through a downturn as seen in 2008 there is a cyclical process during the recovery that can be seen through company earnings.

In the first phase, the benefits of cost cuts and layoffs while noticeable can be watered down as some of the money saved is reverted back into technology investments to help the existing employees become more productive.

Once this first phase completes, there is a period of maximum benefit where those cost cuts remain and the investment ceases creating a nice spread. Eventually this leads to diminishing returns.

However, when interest rates continue to decline and you can retire debt you were paying 6% on to new rates in the 2-3% range you can continue to stretch the good looks of your earnings for quite some time.

Eventually all these cycles lead back to revenues, which is where we are now.

At this stage of the game it becomes more important for companies to show growth in revenues and the recent earnings season has painted a so-so picture for revenue growth. This will be the thing to watch for 2012.

If corporate revenues can attain steady growth then the markets will act accordingly and vice versa if revenue numbers become softer in future quarters. This focus on revenues will make sector and stock selection more important to those investors seeking growth from equities.

Without a doubt 2012 will be another entertaining year. And with the markets currently just points below our KO levels for the bears case we should know fairly soon if we should shift from risking opportunity to risking capital.

This very topic will be discussed in our next writings and events in March where we will attempt to bridge the gap between the bulls and the bears and help you build a portfolio that has a risk reward profile that fits your needs.

Warmest Regards,

Colby McFadden
Quiver Financial
Newport Coast Asset Management


The opinions expressed are those of Colby Mcfadden and Quiver Financial as of January 30, 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.