Oscar Wilde once said, "To expect the unexpected shows a thoroughly modern intellect." To expect the unexpected may be the best advice for investors in 2012.
Despite recent positive economic news, including an unemployment rate that has dipped for the fifth straight month, to 8.3%, there are four major issues that are hanging over the global economy like a Damocles Sword, and that is the European debt crisis, the recessions in Europe and a global economic slowdown, our dysfunctional political system and the possibility that Israel may bomb Iran's nuclear facilities over the next few months.
If Iran closes the Straits of Hormuz that would close off almost 20 percent of the world's oil. If that happened, gasoline prices could soar to $5 to $6 a gallon.
Even with a climbing stock market, the investment landscape could turn hostile at any moment. For the past year, investors have seen turbulence, volatility, and upheaval in the stock market that only happens once in 50 years.
These Are The Four Major Trend Risks To Watch Out For In 2012
Politics: With governments intervening in many economies, it certainly seems like global politics, rather than investment fundamentals might drive 2012 stock market volatility and performance.
American and European politicians have shown utter paralysis in tackling intractable economic problems. Unwilling to make the tough decisions they all know should be enacted to avoid a global economic disaster they continue to "kick the can down the road." With an estimated $6 trillion plus solvency shortfall in eurozone banks and $16 trillion in U.S. public debt, it will take a leadership of far greater caliber to avert an eventual disaster. Unfortunately, that leadership is nowhere to be seen, either in America or Europe.
The bad news is America cannot solve Europe's sovereign-debt and banking crises, but our U.S. stock market could pay a heavy price if Europe fails to solve its problems. U.S. exports will be hit and our banks will curtail lending if they suffer the same loss of confidence as their European counterparts.
Of course, American politicians could overturn our economy completely on their own. Given this is an election year both parties are digging deeper into their opposing positions. This is tailor-made for more of the grandstanding that almost shut down the federal government and nearly triggered a federal default in 2011. The risk of a rerun this fall, before the election, is disturbingly high in 2012.
European Debt Crisis: European banks have agreed to a short-term bailout of Greece's debt for the next three months until the next bailout negotiations start again in May. In talking to officials at the International Monetary Fund (IMF), I am told the current three-month bailout was to give the European Central Bank time to shore up European banks before an inevitable Greek default, probably in June. Several weeks ago the rating agency, Fitch, once again downgraded Greece's debt and stated that it believed Greece would eventually default.
Over the past few weeks, the European Central Bank provided almost 1.2 trillion euros in liquidity through 1% loans to almost all European banks. This was a last-ditch measure to try to stabilize and refinance European banks before the expected Greece default in June.
The greatest long-term threat to the global economy is the high probability that the European politicians make a fatal miscalculation, allowing Greece to default "chaotically," without adequately propping up the region's banks or protecting bigger economies such as Italy, and Spain, from the collateral damage. The result could be a very sharp fall in European GDP and stock markets around the world.
The consequences of failure are almost unthinkable. The combined European economic region, with a gross output of $12 trillion, represents the world's second-largest economy, behind the United States at $14.5 trillion.
If the European debt crisis is not solved, we could see major bank insolvencies, international disputes over multilateral aid packages, international trade and currency disputes, riots and political upheaval with frequent elections and changes of governments throughout the world. It could also cause bank runs, capital flight and soaring bond yields in Portugal, Italy, and beyond.
In the end, I believe European politicians will solve the debt crisis by printing money, deflating the currency and paying off their debts with a 'devalued" euro. Europe could see Japanese-style stagnation for the next 20 years. Recessions in Europe are likely to be much more frequent than they were in the 1980s and 1990s, and the overall growth rates moribund. Oil, gold and commodities could be great investments if governments choose printing money as the solution to their debt problems.
Iran: The International Atomic Energy Association recently announced that Iran has mastered the critical steps needed to build a nuclear weapon, with the aid of North Korea, and Pakistan. This combined with Iran's threat to shut down the flow of oil through the Straits of Hormuz certainly has added an element of uncertainty to the price of oil in 2012.
Iran's apparent determination to develop a nuclear weapon means that an attack on Iran by Israel is likely only a matter of time. An attack on Iran would probably cause stock markets around the world to drop 20% or more - at least for a few weeks until the U.S. re-opened the Straits of Hormuz. The U.S. would have to do this because a sustained spike of oil prices of about $130 to $150 a barrel would most likely be a recession trigger around the world. Gold could be an important hedge during the crisis.
Slow Global Growth: With Europe in a recession, Japan flat-lining and the U.S. muddling through at a mediocre 2% growth rate - when you're growing at 2 percent, there's no margin for error.
50% of S&P 500 (SPY) Index earnings come from Europe, Asia and emerging markets. With the global slowdown, U.S. corporate earnings could inevitably decline. The projections for earnings growth of the S&P 500 Index are 10% for 2012. On the surface that sounds good, but the reality is that they have been lowered in light of the slowing global economic outlook.
Overall, it is hard to see how the U.S. stock market will not slow over the coming year given that 50% of earnings come from outside the U.S.
The good news is that China, India and the United States now account for two-thirds of global GDP growth and the U.S. is better able to withstand a growth slowdown in China, and a recession in Europe.
The U.S. does lots of trade with China, but imports of goods are roughly four times exports, and the exports are just 0.7 percent of U.S. GDP. Exports to the European Union countries are 1.7 percent of GDP. If all of this trade collapsed to zero in the next year (not a realistic assumption), real GDP (which is trending at a 2.5% rate) in the U.S. would still rise by about 0.1%.
In addition, Boeing (BA) just received its largest order ever ($18 billion) from Emirates Airline. Problems and uncertainty in Europe will probably help some U.S. companies win orders over European competitors.
Expect The Unexpected
Can the good times continue on Wall Street? Although investors should expect a short-term pullback over the next few weeks, for now, things look good at least over the next few months.
But the four issues I have outlined above will most likely cause some ups and downs this year.
Investors should remain very cautious and be prepared to try to protect their principal by moving out of the stock market into cash or gold if anything seriously imperils the stock market.