Volume IV - October 2011

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2012 Investment Outlook

A tale full of sound and fury, signifying nothing - this may be the best way to describe the stock market performance in 2011 (and the last decade for that matter).  Of the 252 market days this past year, we saw the DOW swing 100 points or more in 104 of those days.  Despite all this volatility we ended up closing out the year with the broad market index, represented by the S&P 500, completely unchanged (+2.1% if you include dividends).

Year in Review—The core of our market thesis from the prior year ended up coming to fruition.  Last January we targeted a 10% return for the year based on the prediction that “global liquidity and low interest rates will continue  to drive up most asset prices.” In the first half of the year , we saw Markets move close to our yearly target of 10% before losing all those gains to a 20% Summer sell-off inspired by the circus that was the U.S debt ceiling debate.  From a big picture standpoint, our prediction that “there is a significant chance of markets overheating in the first half of the year setting us up for a 10 to 20% correction,” was fairly spot-on.  However, the selection of our favorite asset classes for 2011 was a bit hit or miss.  Ironically, In the flight to safety that occurred during the Summer, U.S. bonds and the dollar strongly appreciated in value.  As a result, emerging markets ended up suffering along with everything else that was not dollar denominated.  Although most of these Markets outperformed their developed European peers, the absolute performance was sub-par.  Commodities, on the other hand, did end up outperforming the broad markets for the bulk of the year.  

We’ll be looking for one of our predictions from 2011 to continue into the new year.  Previously, we said that there would be a reversal in certain “investment grade” bonds that would be shunned by investors, thus increasing the risk of holding long-term bonds.  Long-term U.S. Treasuries strongly bucked this prediction in 2011 and ended up being one of the best performing assets of 2011, returning 23%.  Long-term bonds in Europe were a different story however, and saw large losses in value due to huge fear inspired  spikes in borrowing rates bringing yields up to 7%.  We are expecting to see further contagion of this effect in 2012 and beyond with it possibly even spreading to the U.S. or Japan. While long-term bonds in these countries may appreciate in a short term flight to quality, their risk should not be underestimated.  Should investors begin to exit U.S. or Japanese bonds in a similar fashion to what occurred in Europe, don’t be surprised to see long-term Treasuries lose 25% or more.

2012 Outlook & The Great Monetization-The budget satire in Greece this past year has made it clear to us that after the Lehman bankruptcy in 2008 and ensuing financial crisis, world leaders will avoid letting significant amounts of sovereign debt default at all costs.  The issue of massive debt levels has not been resolved and will only continue to climb higher.  If countries refuse to accept default as an answer, then the only other viable resolution is monetizing debt (printing money to pay off bonds).

Unfortunately, under this backdrop, a slow economy, and a presidential election year, we  expect most asset classes to flounder in 2012.  We expect both stocks and bonds to give returns of 5% or less and top out before the end of March.  That being said, if investors like the results of the November elections then we could close out the year with a strong Santa Claus rally.

Another continuation of our 2011 thesis is  we expect central banks around the world to continue to  fire up the printing presses and thus predict continued outperformance of the commodities asset class.  We look for Gold to reverse its recent sell-off and to finish 2012 over $2,000/ounce.  Also, don’t be surprised to be paying over $4/gallon for gas nationwide come summer time.

Basically, we expect 2012 to be a year full of uncertainty much like the second half of 2011.  Likely this will lead to more volatility and wild swings in the markets .  Do not be afraid to take gains where you can find them.  As we have been saying for the past two years, in this environment you need to be a “renter” of investments, not an owner.  In fact, the majority of mutual fund and hedge fund managers ended up underperforming the indexes and their benchmarks, thus showing that even the professional money managers have not been able to take advantage of the volatility.  Unfortunately, overweighting cash has been the best way to avoid volatility this past year and likely will be the case again in 2012. 

The silver lining to our 2012 outlook is that we expect corporate profits to continue improving even if the lack-luster economy and high unemployment continue.  During 2012, we hope that many of the economic issues facing the world will begin to be addressed.  It will be impossible for the debt problems plaguing nations to be eliminated overnight, but if a game plan can be enacted to begin the deleveraging process, it could be extremely bullish for the world stock markets moving forward.

For the time being put a premium on protection.  We expect 2012 to be a year where a strong defense will provide a strong offense for making profits 12 months from now.  After all, imagine how excited investors will be when December 22nd rolls around without the world ending.  Lets all hope the Tarheel Advisors’ market predictions are more accurate than the Mayans and Nostradamus.

-Ryan Glover, CFP®