What We Can Expect From 2012: What Is Right And What Is An Illusion

by: Keith Springer

Stocks opened up the first day of the new year with a pretty good pop higher, leading many to pronounce that the problems of markets past are behind us. Add this to the market’s road to nowhere last year, and it may appear that stock market beast be tame. Unfortunately, much of the angst and agony has been cleverly masked as stocks have surged over 1% on the first trading of the year 4 of the last 6 years, and we know how well that’s turned out. What’s worse, however, is that last year’s returns don’t tell the true tale.

Although while the S&P 500 was down slightly for 2011, when we look deeper to include a larger sampling of stocks with the Institech 4000, we get a more realistic -8.7% decline. Of course it is a global market these days, so if we take the average life style/target date fund, international portfolios and emerging markets, it was more of a train wreck. The MSCI All Country World Index (ex. the U.S., symbol ACWX) posted a -14.0% loss and many popular country indexes did even worse, as you can see below.

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Of course that doesn’t take into account what a heart attack year 2011 really was as we rode the roller coaster ride to hell and back. During the year, the S&P 500 dropped about 20% from peak to trough while the Russell 2000 dropped -29.69% with losses of over -30% being the global norm. The chart below illustrates the pain we endured so do not get complacent.

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But this is a new year and with it comes new hope. So … what can we expect from 2012?

There are 3 main issues that will decide the direction of the markets and therefore investors’ blood pressure and sleepless nights.

1. Earnings. When you get right down to it, stocks trade based on earnings and are driven by earnings surprises. In each quarter for the last three years earnings have consistently beaten expectations only to have the next quarter’s expectations lowered mid quarter. The current in between quarter is no exception as 96 companies in the S&P 500 have revised their 4th quarter guidance down, while more analysts jump on the bandwagon due to Europe’s slowdown and slower growth in emerging economies.

I can’t argue with the logic except to say that, “if it’s obvious, it’s obviously wrong!” Stocks will likely beat expectations again. However, when they don’t, that will be the signal to get out of stocks and put your personal exit strategy to work.

2. Europe. The ECB (European Central Bank, their version of our Federal Reserve) finally seemed to come to grips with the problem and came up with a strategy. This plan is called the LTRO (Long term repo operation) which will provide three year loans to banks. This is essentially a European QE (Quantitative Easing) program and more importantly signals a willingness by the ECB to act decisively.

Europe’s crises is off the front page for now, which should help. There will still be continued daily angst over the debt crises, but the threat of an implosion has been put off for a little while at least. However when Europe’s problems become too great for the ECB to deal with, the whole world will go up in flames with it.

3. The Economy. The economy has been looking stronger the last few months and economic releases have been beating expectations. This is very likely due to QE2 which was announced in November 2010. A stimulus program like QE2 takes 6-9 months to be felt in the economy and last for about the same.

Therefore the economy will look like its improving for perhaps a few more months, which will build confidence in consumers and investors. When the numbers start to surprise on the downside, investors will panic and stocks will suffer. However, the wildcard is of course QE3.

For right now, although the market had a nice new year’s pop, it looks a little overbought and extended and I expect a pullback. We’ll have to see how the technical supply and demand levels look in a breakout in either direction. However, the downside risk appears greater than the upside reward, so investors should focus on the market’s sweet spot.

Naturally all the world’s economic problems are several years away from being solved. The European crisis is essentially a world crisis, caused by the majority of the entire developed world’s populations getting older in unison and past their peak spending years and trying to retire all at the same time. Add these demographic challenges to an enormously over indebted/over-leveraged population in the middle of a massive global deleveraging and you have the “Goliath” we are all facing. Of course, investors armed with the knowledge of what’s truly going on and prepared with the correct strategy will weather the storm and prosper.

Investor Strategy:

Growth investors can stay in this market until there is a breakdown in any of the three above. The great movers such as Apple (AAPL), Google (GOOG), Intel Corporation (INTC), Microsoft (MSFT), Cisco Systems (CSCO), Dell (DELL), Caterpillar (CAT), General Electric (GE) and Yahoo (YHOO), will do very well in a good market. In addition, Gold and silver can be bought here, SPDR Gold Shares (GLD), Market Vectors Gold Miners ETF (GDX), Newmont Mining Corp. (NEM), Goldcorp. (GG), Freeport-McMoRan Copper & Gold Inc. (FCX), Silver Wheaton Corp. (SLW) and ProShares Ultra Silver (AGQ).

Investors must be tactical and avoid that buy-and-hold (hope) mentality. “Invest for need, not for greed”. If you are not investing for income and dividends, you are just gambling. The best opportunities currently exist in corporate bonds, preferreds and high income stocks, with many yielding over 8-10% along with upside potential. There are still plenty of places to make money in this market without a lot of risk … if you know where to look. Stick with dividends.

  • Legacy Reserves LP (LGCY) –- yielding 9+%
  • Vanguard Natural Resources (VNR) – yielding 9+%
  • Compass Diversified (CODI) – 11% yield
  • Terra Nitrogen (TNH) –10 1/4% yield. Makes and markets farm products. One of the few hot sectors in our economy. It is yielding 8%.
  • CVR Partners, LP (UAN) – yielding 10+%
  • Breitburn Energy Partners (BBEP) – yielding 9+%

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.