|Forbes.com, Winter, 2011. This article was written with Oliver Pursche, the Co-Portfolio Manager of GMG Defense Beta Fund. It was part of a series of articles developed under an agreement with forbes.com to work with a variety of contributors and assist them in delivering actionable investment ideas each week. The site, forbes.com is one of the top 500 sites in the world with nearly 10 million subscribers and nearly 100 million page views a month.|
Last week I made five bold predictions as part of my 10 market predictions for 2012. In quick step they were:
Prediction 1: The S&P 500 Index will rise by at least 10%.
Prediction 2: Greece will begin official negotiations to exit the euro.
Prediction 3: President Obama wins reelection.
Prediction 4: China will allow the Renminbi (Yuan) to rise nearly 8% against the dollar.
Prediction 5: The commodity bull run resumes in 2012
Now, here’s the other five.
Prediction 6: Europe will spend most of the year in a recession.
Despite a reasonably good performance in manufacturing among some of the northern nations–Germany will lead here–the overall weakness of the economy will cause Europe to slide into a recession. Unfortunately, Greece’s exit from the euro (see first five predictions) will exacerbate the problem. That said, the recession there will be relatively mild, and the U.S. economy will not be pulled into a recession because of problems over there. Most of the key data points stateside–productivity, manufacturing, factory capacity–are pointing up and the problems in Europe are already factored into expectations.
Based on these expectations, I would recommend underweighting European equities. However, I would suggest there are some good values in European multinationals, especially those who derive most of there earnings from outside the Eurozone. We’re buying Royal Dutch Shell (RDS-A), a truly global energy firm (I mean seriously, have you seen any oil derricks in the Zider Zee?), whose 4.7% dividend bests the Energy Select Sector SPDR (XLE) by more than five percentage points and Exxon Mobil (XOM) by nearly two and a half points.
Predictions 7: The United States will avert recession, with GDP growth below 2%
Despite being buffeted over the last three years, the U.S. consumer remains strong, and with confidence gradually building, we are seeing some of the impact of pent-up demand for consumer durables. This will be largely masked during the first quarter as Greece begins negotiation to exit the Eurozone which will deliver considerable havoc on the markets.
However, wider recognition that a recession has been averted will kick in during the second quarter, and this belief will act as a catalyst for stocks. The announcement of first quarter GDP, announced during the second quarter, will surprise to the upside, and positive revisions to the third and fourth quarter of 2011, will drive the final stake through the heart of recession fears.
The strategy to play these trends is to get fully invested in early 2012, when markets are most likely to pull back on negative sentiment and news out of Europe–which for us means no more than 10% in cash.
Prediction 8: The 10 Year Treasury bill yield will move towards 3%
Currently rates on 10 year Treasuries are hovering at 2%, but during 2012 will rise to 3% for a variety of factors. Specifically, the unannounced yet nonetheless very real QE III will fail to keep rates down because the flight to safety will be less urgent in 2012 and because the specter of inflation will raise its head. In short, the Federal Reserve is going to have to incent investors to buy treasuries.
To avoid the downside of rising rates (bond prices move inversely to rates) investors with a fixed income allocation should move into shorter-term maturities: no longer than five years, and preferably three years or less for municipal and corporate bonds, as well as Treasury securities. The time to shift into shorter term maturities is now, to take advantage of lower prices, and position your-self for a gain in 2012.
Prediction 9: Brazil’s stock market, one of the worst performers in 2011, is going to be one of the best performers in 2012.
As of this writing, the Brazil Bovespa Stock Index was off about 16% for the year. Expectations for Brazil were high going into 2011, and got dashed–despite an admirable performance by the Brazilian economy–putting a damper on equities there. Moreover, the real’s inexorable climb against the dollar (about 40% over the past three years) hampered Brazil’s exports.
But I believe the market sold off far more than it should have and 2012 is going to be a different story. The central bank there is already loosening monetary policy to spur on growth, and stabilization in the currency should stave off the rise against the dollar. But an announcement in early December that the 2% tax on foreign equity investors (coupled with 6% tax on foreign debt holders) has been eliminated will, I think, bring investors off the sidelines, and into Brazilian equities.
The easiest and most obvious way to play this is with the iShares MSCI Brazil Index Fund (EWZ). It’s off about 23% so far in 2011.
Prediction 10: More shoes will drop in 2012.
Though I’ve predicted equities will rise by some 10% in 2012, I believe their increase has been and will be retarded by a continuous ebbing of confidence in what were once unassailable institutions. To me, this helps explain a near 40% rise in corporate earnings since the depths of the financial crisis being met with a tepid response at best by equities.
The most recent, sad and inexplicable experience at MF Global, followed by sworn testimony from former senator and New Jersey governor John Corzine, that “he”, in essence, had little specific knowledge, is the kind of executive behavior that set off protesters around the country in the Occupy Wall Street movement.
Perhaps more sadly, we’re not done, and 2012 will see another shoe drop that continues to undermine investor confidence. Of this I’m sure because the culture of greed has yet to be expunged. Sarbanes-Oxley was a good start, and the Dodd-Frank Act is well intentioned, but you can’t legislate morality, and the current generation of leaders have proven themselves to be hard learners.