It's that time of year again when we do our best to put our best "guessing hat" on as to what the new year may bring in terms of the economy, the markets and the world. This is a condensed version of the full report that was released this past weekend.
A Review Of 2011 Predictions
Our predictions for 2011 were mostly against the mainstream media punditry but on average we fared well overall. It is always an interesting exercise to review our calls with the benefit of hindsight. Here is a short review of what we said in January for the upcoming year.
1) The Stock Market: With 2011 being the third year of a presidential election year most analysts had predicted a double digit return year and new index highs for the year. We stated that: "...we are not in a normal economic cycle by any means but as long as the government is willing to ply the strength of printing presses against the weight of the market – statistically the markets should finish higher than where they began. However, it doesn't mean that it can't, or won't, be a bumpy ride along the way." CHECK
2) US Economy – May Be Weaker Than Expected."While the media is replete with calls for 3.5% to 4.00% growth in GDP next year our view is somewhat more sanguine in nature with GDP growing closer to 2-2.5% by the end of the year." CHECK
3) Eurozone Crisis."One thing that we are fairly confident about in the coming year is that the Eurozone Crisis will reemerge primarily in the PIIG countries with Portugal, Greece, Ireland and Spain back in the soup needing more money and assistance." NAILED IT
4) US Dollar vs Euro. "We expect that both the Eurozone crisis combined with tighter fiscal policy will push the Euro to below parity with the US Dollar." (This occurred but after a decline in the USD – NEUTRAL.)
5) US Stocks Outperform International/Emerging Markets. "We do think that US will outperform international markets this year and being overweight US and reducing international exposure will pay off... Very likely there will be another major disruption in the Eurozone in the coming months which will put pressure on their markets..." CHECK
6) Stock Market Correction – "...there is a high probability of a substantial correction (10-20%) during some point in the coming year." NAILED IT
7) Interest Rates Rise - We expected interest rates to continue their rise that began with QE2 and expected a QE3. However, the expiration of QE2 with subsequent follow up and rates fell as money moved into the safety of bonds and cash. FACE PLANT
8) Commodities Continue Bull Market - The commodities index peaked in May and has been correcting for the last half of the year with a flat return for the year. HIT AND MISS
9) Housing Prices Continue Secondary Decline. "There is no recovery in housing. Period. We said this would be the case two years ago and continue to pound the table on this front. There can be no recovery in housing as there is too much inventory both visible and invisible (banks holding inventory off market). Until we can go through the deleveraging process and the banks own up to their problems and begin to write these assets off their books, we will continue to suffer negative shocks to homes until prices come in line with long term historical norms." CHECK
10) Muni Bonds Hit The Skids. After an initial hit to muni bond prices states got off their duffs and began to straighten out budgets. That, combined with massive injections of government dollars to stave off financial pressures, and muni bonds firmed up. I don't mind missing this call as the alternative to being right was far worse. EPIC FAIL
Overall, our score was roughly 7 out of 10 with most of our calls being pretty out of mainstream territory as they tended to harbor a bearish tone. However, they served us well and kept us out of the 20% stock swoon this summer.
A Note About Risk Management
This is why we manage portfolios from a risk managed approach – greater returns are generated from the management of "risks" rather than the attempt to create returns. Our philosophy was well defined by Robert Rubin, former Secretary of the Treasury, when he said:
As I think back over the years, I have been guided by four principles for decision making. First, the only certainty is that there is no certainty. Second, every decision, as a consequence, is a matter of weighing probabilities. Third, despite uncertainty we must decide and we must act. And lastly, we need to judge decisions not only on the results, but on how they were made.
Most people are in denial about uncertainty. They assume they're lucky, and that the unpredictable can be reliably forecast. This keeps business brisk for palm readers, psychics, and stockbrokers, but it's a terrible way to deal with uncertainty. If there are no absolutes, then all decisions become matters of judging the probability of different outcomes, and the costs and benefits of each. Then, on that basis, you can make a good decision.
It should be obvious that an honest assessment of uncertainty leads to better decisions, but the benefits of Rubin's approach, and ours, go beyond that. For starters, although it may seem contradictory, embracing uncertainty reduces risk while denial increases it. Another benefit of acknowledged uncertainty is it keeps you honest.
A healthy respect for uncertainty and focus on probability drives you never to be satisfied with your conclusions. It keeps you moving forward to seek out more information, to question conventional thinking and to continually refine your judgments and understanding that difference between certainty and likelihood can make all the difference.
The reality is that we can't control outcomes; the most we can do is influence the probability of certain outcomes which is why the day to day management of risks and investing based on probabilities, rather than possibilities, is important not only to capital preservation but to investment success over time.
2012 – Anything Other Than The Apocalypse Counts As A Win
So, it is now time for our prognostications, forecasts, guesses and expectations for 2012. However, December 21, 2012 is also the end of the Mayan calendar which puts us into the camp that, regardless of what happens in the coming year, anything other than the "end of the world" counts as a win.
1) There Are Risk To US Economic Growth Projections - The mainstream economic analysts are going into the end of 2011 with very strong predictions for 3.5-4% annualized economic growth in the U.S. We have been vocal over the last year that this is highly unlikely to occur for several reasons.
2) Eurozone Crisis Will Continue -The 2011 deluge of capital through currency swaps by the Federal Reserve and three-year term loans to banks have done nothing to resolve the liquidity and solvency crisis plaguing the Eurozone. While these operations will postpone the inevitable – they are not a solution to a spending and debt issue
3) Real Estate Continues To Struggle - Despite rumors to the contrary; real estate will continue to struggle not only in 2012 but well beyond. The bursting of the real estate/mortgage bubble is not something that is solved in the course of a couple of years – especially in a case where the excesses took two decades to accumulate.
4) Interest Rates To Remain Low - No real surprise here but interest rates will remain range bound at these lower levels throughout 2012. With the Fed maintaining its zero interest rate policy into 2013 there is no real catalyst on the horizon to push interest rates higher.
5) US Dollar - Strength Into 2012 - The U.S. dollar will likely be the bright spot of 2012 after effectively being breakeven in 2011. The continuation of the Eurozone crisis will continue to push dollars into the U.S. currency as a safe haven.
6) Oil Will Be Higher And Lower - in 2012 we expect that oil prices will only be able to sustain the $100 plus levels for a limited time as the impact on the economy becomes apparent.
7) Gold 0, Hey It's Shiny - The continued belief that the world is on the edge of implosion will continue to drive money into the fear trade. However, for 2012 it is likely to be an investment that underperforms as the consolidation process continues.
8) Domestic Markets Outperform International - Money has to go somewhere and if you look around the world today there are few places to safely make large investments where liquidity, visibility and stability remain. The U.S. dominates the world in this regard.
9) Corporate Profit Contraction - One of the big shockers to the investment community will be the unexpected and fairly sharp decline in corporate earnings. This is one point that supports the trading range expectation for 2012 in the S&P 500 Index. In 2012, we expect a slower rate of growth in corporate earnings, weakness in forward guidance and concerns about international issues abroad to dominate reports.
10) Wild Card - Obama Is Re-Elected - I say this because I think this is what is going to happen. With more than 46 million people collecting food stamps and 86 million people no longer in the work force – the promises of a man to keep you in your home, put more dollars in your pocket, take from the rich to give to the poor and pointing fingers and blame at those "evil conservatives" will ring home with the average American.
There you have it. My predictions for 2012. MY JOB is to try and give you as many of the facts as possible so that you can make your own financial decisions going into the coming year. One of my favorite quotes is by Howard Marks and is a principle that we live by in our little shop;
"Given the uncertain nature of the future, and thus the difficulty of being confident your position is the right one – especially as price moves against you – it's challenging to be a lonely contrarian."
As we enter into 2012 it may pay to be a little cautious by raising some cash - as it promises to be a rough year. However, like I said - anything other than the "apocalypse" and we can count 2012 as a win.