|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.|
Live by the sword, die by the sword. The fact is everyone in the financial services or wealth management business has thoughts–secret or otherwise–about what they feel the markets will do next year. Question is, are they brave enough to go on the record about it?
And I’ll go one better. This time next year I’ll revisit these predictions and either pillory myself, or emboldened, make 10 more. Here’s five bold predictions for 2012, and next week, five more.
Prediction 1: The S&P 500 Index will rise by at least 10%.
This may not be as brave as it seems. For this one I’ve got history on my side. Since 1900, the market has gone down just three times in a presidential election year: 1960, 1980 and 2008. But market psychology aside, if you believe that we will avoid a global recession–and I think we already have (see some of my other predictions below)–wider recognition of this will act as a catalysts for stocks in the coming year.
If you have a lot of conviction this prediction will come true, you might consider buying the Russell 1000 High Beta ETF (HBTA). If you think the election will work its magic, but that the patient still has a bad case of anemia, you might consider buying the Russell 1000 Low Volatility ETF (LVOL).
Prediction 2: Greece will begin official negotiations to exit the euro.
Nobody wants to see this because the implications are severe. If Greece drops the euro in a dramatic fashion, we will see a huge flight of capital out of Spain, Italy and Portugal, into the northern countries such as Germany, Holland and Denmark. Because of this Greece will exit in a more structured and orderly fashion. Likely, the country will negotiate to still pay fifty cents on the dollar for its sovereign debts then reintroduce the drachma alongside the euro for a three year time frame, with the decoupling occurring over time.
For investors, it’s hard to play the upside of this by for example, shorting country-specific ETFs. Central banks will be heavily involved in steering the transitions, and it’s never wise to fight central banks. A better strategy: underweight international and emerging market exposure.
Prediction 3: President Obama wins reelection.
In spite of a weak economy and continued high unemployment the republican party’s own lack of leadership and cohesiveness will weaken them to the point where Obama looks like the better option. Moreover, the party’s willingness to pander to the right wing will make them unpopular with middle class and middle of the road voters. As a result, I would expect the election to be marked by record low turnout frustration, apathy and disgust, but at the end of the day, Obama will have won four more years in office.
Prediction 4: China will allow the Renminbi (Yuan) to rise nearly 8% against the dollar.
Slowly and rather quietly, China has already begun to loosen monetary policy. For instance, at the end of November, it lowered the reserve requirement for six banks. Unlike here in the U.S. where monetary policy is carried out through a series of complex market transactions, China’s government simply told these banks what to do. China will continue to lower rates in the first half of the year to spur on growth. Europe accounts for roughly 25% of China’s exports, and lower demand from Europe will be material for China.
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I firmly believe that the Chinese government’s monetary policy is being dictated by more than just supply and demand. Just 20 years ago, the Chinese people lived in conditions that were equivalent to those we experienced in this country during the 19th century.
The Chinese government realizes it must keep this progress going or face massive social unrest. Count on them to do everything they can to maintain growth. Looser monetary policy may the least of it.
The way for investors to play this is to own consumer staples multinationals. We own McDonald’s (MCD), Caterpillar (CAT), Yum Brands (YUM) and Procter & Gamble (PG). Though we do not own it, the Consumer Staples Select Sector SPDR Fund (XLP), is another way to play growth in China.
Prediction 5: The commodity bull run resumes in 2012
One reason commodities cooled off in the latter half of 2011 was because of concerns about a global slowdown or worse, recession. I don’t believe this will happen, and in fact we forecast that global GDP should be around 3% in 2012. China, thought by many to be headed for a crash landing, will have a soft landing instead. Europe will have a recession, but it will be mild and here in the U.S., we will avert a recession, and instead deliver sub par GDP growth of 2%. As a result, global demand for agricultural and base metal commodities will remain in tact, and in some pockets will be superlative. The avoidance of a global recession or slowdown will act as a catalyst for commodities related companies.
Investors can play this by investing in global agricultural stocks. We are long Monsanto (MON), but Deere (DE), Caterpillar (CAT), and the PowerShares DB Agriculture Fund (DBA), none of which we own, are also viable candidates. To play the metals side of a surge in commodities, investors can look at PowerShares DB Base Metals Fund (DBB).
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.