10 Low Probability Possibilities For 2012

by: The Financial Lexicon

As we enter 2012, it is useful to think through a variety of scenarios that could have profound direct and indirect effects on our portfolios. What follows is a list of ten events, each of which deviates greatly from the consensus views of industry pundits. While not all of the following ten events would be considered Black Swans should they happen, given current consensus expectations for 2012, each member of the list would certainly be a candidate for a mind-boggling event.

I categorize these types of events as low probability possibilities because given what we know about the current state of the financial world and political climate, they cannot realistically be ruled out. At the same time, given that known unknowns often get at least partially priced into a security before an event occurs, some of the happenings the world will experience in 2012 might not have as serious an effect on security prices as one might think. Only time will tell.

Without further ado, I present ten mind-boggling low probability possibilities for 2012:

1. 30-year Treasury dips under 2.00% - With a significant worsening of the European debt crisis or any serious market-wide fears of recession in the United States, a sub-2% 30-year Treasury (NYSEARCA:TLT) can’t be ruled out. Key resistance levels (from a price perspective) to keep an eye on before 2% would be reached include the October 4, 2011 low around 2.70% and the December 2008 lows around 2.50%. Also, keep in mind that since 2004, Treasury bonds have shown an affinity, from a yield perspective, for topping out in the second quarter. The one exception to this was 2011, when rates topped out in February. Although, despite the 30-year Treasury bond reaching a peak in yield for the year near 4.80% in February, a couple short months later, in early April 2011, yields were still hovering in the mid-to-upper 4.60%s.

2. The DJIA-to-gold ratio narrows to 6:1 - Currently at 7.80, a narrowing of the DJIA-to-gold ratio to 6:1 could happen in a variety of ways. One imaginable scenario would be a gold (NYSEARCA:GLD) price of $1,800 per troy ounce and the DJIA at 10,800. One might envision this scenario occurring under further stresses in the EU. Should the United States head into recession at the same time Europe is experiencing a sovereign default or two leading to margin calls and massive deleveraging, it wouldn’t be out of the realm of possibility for the DJIA to return to levels between 6,500 and 7,500, thereby requiring a gold price between $1,083 and $1,250. Perhaps we see more money printing taking the DJIA to 14,000 with gold heading towards its inflation-adjusted all-time high.

For those who prefer to compare gold to the S&P 500 (NYSEARCA:SPY), if one were to convert the aforementioned DJIA-to-gold scenarios to the S&P 500, it would likely translate into an S&P 500-to-gold ratio somewhere in the neighborhood of 0.61, down from its current ratio of 0.80.

3. The Federal Reserve does not do QE3 - It seems like everyone expects the Federal Reserve to eventually do QE3, and given the pattern of QE in 2009, QE2 in 2010, and Operation Twist in 2011, it only seems natural that the next version of QE will occur in 2012. However, with Operation Twist scheduled through June, and the Dow Jones Industrial Average (NYSEARCA:DIA), S&P 500, and oil (NYSEARCA:USO) all trading well above the levels at which rumors of QE2 began to leak, absent a major market sell-off, it might be longer than people think before QE3 becomes a reality. Perhaps that realization will ultimately contribute to the market sell-off that will eventually bring about QE3.

4. Ron Paul runs as an independent and wins the presidential election with less than 35% of the vote - Given his age, this is likely the last shot for Congressman Paul to become President Paul. He is polling strongly in Iowa and is growing in popularity, especially among young adults. It’s hard to imagine he wins the Republican nomination, and he likely knows the Libertarian party has no chance of getting a candidate elected President in 2012. Ron Paul has already announced he is not running for reelection in the House of Representatives but instead will focus his efforts on “winning the Presidency.” Did Congressman Paul really believe he could win the Republican nomination when he made that statement? If not, what exactly was he planning to do with his time this summer and fall?

5. Two countries currently using the euro announce the intention to stop using the euro - While many might expect Greece to eventually drop the euro, perhaps even in 2012, a second country surprisingly dropping the currency in the same year as Greece would likely cause extreme uncertainty about the euro and severe stresses in financial markets. Currently, the following 17 member states of the EU use the euro: Belgium, Germany, Estonia, Ireland, Greece, Spain, France, Italy, Cyprus, Luxembourg, Malta, The Netherlands, Austria, Portugal, Slovenia, Slovakia, and Finland.

6. IBM, CL, MCD, MA, KO, SPG, NKE are all down by at least 15% (excluding the dividend) at some point during the year, although not necessarily at the same time - While an entire article could be devoted to a more in-depth explanation of why these stocks might fall, let me simply say this: it will only take a relatively small contraction in the multiple to achieve a 15% drop in each of these stocks. When thinking about valuations, an investor should not just focus on absolute valuations but also recognize the importance of relative valuations.

When it comes to relative valuations, I am not just referring to market-wide valuations (S&P 500 for instance), historical valuations for each industry in question, or valuations relative to a competitor. Rather, I am also referring to valuations as they relate to the macro environment in which we live today, structural changes in the way debt is viewed by various entities, and negative inflation-adjusted wage growth for huge segments of the U.S. population. Earnings can still rise in 2012, and the stocks could drop 15% on a multiple contraction resulting simply from a market-wide margin call/deleveraging sell-off spurred by events in Europe. These have been very popular stocks people have been hiding out in. Even in the event of a market-wide sell-off, many investors would be stunned that these darlings of the stock market could drop by that much.

7. The unemployment rate falls in 2012 despite sub-1% growth - At the rate people have been defined away from the unemployment rolls over the past few years, it shouldn’t surprise anyone to one day see the U3 measure of unemployment at levels typically considered full employment. This could happen despite simultaneously rising actual numbers of unemployed and underemployed.

8. Shipping stocks end the bear market they are in despite worries about overcapacity, and a few of them double in 2012 - Over the past few years, financial analysts have pointed to declines in international shipping prices as reflecting the extreme overcapacity of ships in the industry, rather than a lack of worldwide demand for various commodities. Given the overcapacity still lingering in the industry, some might find it surprising that the Baltic Dry Index (BDI) closed up on the year in 2011. In fact, at one point in October, the BDI had more than doubled from its February 2011 lows. Is it possible that after years of vicious declines, a high-profile industry bankruptcy from General Maritime (NYSE:GMR), and the extreme financial stresses recently announced by Frontline (NYSE:FRO), that now is the time to pick up the stocks of those companies you believe will make it through this dreadful bear market in shipping rates? Perhaps this is an example of a time when investors should put to practice Warren Buffett’s famous quote, “be fearful when others are greedy and greedy only when others are fearful.”

9. Tim Tebow and the Denver Broncos win the Super Bowl – For those of you who believe in the Super Bowl Indicator for stock market returns, the Denver Broncos winning the Super Bowl would mean a year of negative returns for the markets. From a mind-boggling perspective, when was the last time you saw a quarterback or team with these statistics win a Super Bowl? Completion percentage: last among starting quarterbacks; passing yards per game started: just 150; a team with a negative 81 point differential, which is eighth worst in the entire league; and finally, a team with a losing home record, a .500 overall record, a three-game losing streak to end the season, and an incredible seven out of eight wins by four or fewer points. However, the Denver Broncos are in the playoffs, so their winning the Super Bowl is a possibility.

10. The Chinese Yuan (NYSEARCA:CNY) weakens back to 6.83 to the dollar - From July 2008 to June 2010, China kept its currency’s exchange rate to the dollar relatively constant at around 6.83. Since that time, the CNY has been slowly appreciating against the dollar to its current level of around 6.30. If you think the idea of a serious Chinese slowdown is financial heresy, then the possibility of the rate reverting back to 6.83 in 2012 must be completely mind-boggling. However, if the Chinese real estate market is indeed on the verge of a serious decline at the same time the European debt crisis reaches an apex, the hit to Chinese exports combined with large real estate price declines just might be enough for the government to decide it made a mistake letting the currency appreciate over the past year-and-a-half.

As you might expect, there is much more that could be said about each of these low probability possible events. I hope you will find the list useful when thinking through what impacts various unexpected events might have on your portfolio as the year progresses.

Wishing you happy investing in 2012!

Disclosure: I am long Treasuries, although not the 30-year Treasury bond. I am long gold. I am long various stocks that are a part of the DJIA and the S&P 500. I am not long any stocks mentioned in this article.

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