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I wrote this for a publication at the beginning of the year. Thought you might enjoy it.

Individual Results May Vary

Hopes for a big ending to 2011 faded last week as the euro was hit and prices of distressed European bonds fell. Traders did manage to put in one positive day on the week which kept the major indexes from straying too far from unchanged. For the year the narrow Dow 30 stocks rose by 5.6%, but the broader S&P index was astonishingly unchanged for all of 2011. That seems incomprehensible given the tumultuous year. Of all the surprises in 2011, perhaps closing the year absolutely unchanged was the most surprising.

You are no doubt familiar with the ad disclaimer “Individual results may vary.” Those are most common at the end of ads for the latest weight loss miracle cure. How did that guy lose 70 pounds when you only lost 10? Individual results may vary. That same disclaimer can be used in investing. While the broad S&P index ended unchanged, your investments might have performed much better or much worse. If you followed a conservative path of cash, high quality bonds (no high yield bond funds), and quality dividend stocks, congratulations! You beat Wall Street. If, on the other hand, you heeded the Wall Street advice at the beginning of 2011 you might want to toss your 401ks when they hit the mailbox this month. At the beginning of 2011 Wall Street had a very strong consensus that stocks would move higher by 15-20%, investors should move money into foreign markets (especially emerging market stocks), buy commodities, and avoid U.S. treasuries like the plague. Stocks were flat, foreign stock markets fell by 15-20% generally, the broad commodity funds all fell on the year after the bubble burst in April, and U.S. treasuries was the best performing investment in 2011.

The Wall Street consensus for 2012 is less concrete than at the beginning of 2011, but Wall Street expects stocks to rise 15-20%. Wall Street always expects stocks to rise. Selling you stocks is their business. They wouldn’t have anything to gain by telling you that their product was going to stink for the coming year. But the consensus is a bit more divided and for good reasons.

The list of potential road bumps in 2012 is long but of course starts with Europe. Wall Street mavens say the euro will survive, and the worst of the possible market unrest will be over by mid-year. Wall Street experts also believe that the economy will then begin to advance more strongly for the balance of 2012. Generally, the consensus is that the few months of 2012 will be unstable and volatile but followed by several months of growth and stability. In other words, stocks down early in the year but roaring ahead later.

I’m not taking a contrarian stand just to be contrary to Wall Street’s view, although that’s usually the best bet, but I expect a different outcome. If you haven’t totally blocked from your mind what happened in 2011, you’ll remember that the biggest stock market rallies came after the multiple euro rescue efforts following each crisis. The first three months of 2012 will present similar opportunities. There will be endless summits, “secret” meetings, and numerous proposals to save the euro from extinction. I expect those events will actually help stocks early in 2012.  But reality will settle in that nothing positive will be forthcoming from the tumult in Europe. Most importantly to us, regardless of what “solutions” are achieved in Europe, the European economy will suffer. Remember that the combined European Union economy is actually larger than that of the U.S. The U.S. will suffer mostly the backside of the storm. Europe will be more of a drag on South America and Asia, but the resulting weakness in those economies will hamper our prospects as well. I think our best economic numbers of 2012 will be early in the year, not later. This week in fact we should have two positive reports, one manufacturing index and the monthly Nonfarm Payroll report. I believe the U.S. can avoid a recession, but the risk for the economy is to the downside not the upside.

There are wild cards aplenty. A China economic meltdown on a crumbling real estate market? Another surge in oil prices brought on by strife in the Middle East? A surprising plunge in Russia’s economy that leads to a civil unrest? What we don’t know we don’t know? (That last one was courtesy of Donald Rumsfeld.) The point is we just don’t know what will become the issue of 2012. You’ll notice I did not mention the 2012 election. That’s because it is simply irrelevant for the 2012 economy and market performance. The government will not be a factor this year; that will come in 2013. It is certainly logical that Europe will top the list for the second straight year, but you can never be certain.

One thing that does look certain is that interest rates on the long-end of the market will not fall as much as in 2011. If they were to do so, the U.S. 10-year Treasury note yield would end 2012 at 0.50%. Not impossible mind you, just not very likely. I expect rates will stay very low again in 2012. With the uncertain global economic picture, I cannot make the case of a significant rise in rates. For those of still on fence about buying a house or re-financing your mortgage, that’s good news. Time is on your side. For those savers among us, well, we’re getting used to paltry returns.

If you enjoyed the volatility in the markets in 2011, chances are good you are going to love the volatility in 2012. I can see reasonable prospects for a trading range on the S&P of as low as 900 to as high as 1400 or so. It’s also possible that the market will end 2012 unchanged again, but guessing on the stock market isn’t the point. If the twists and turns in the markets were unsettling to you last year and made you question your retirement plans, etc, you need to take action now. No more excuses. Get help from trusted and qualified sources, and get educated. Do not blindly follow Wall Street’s annual marketing pitch for certain wealth. Individual results may vary is a warning, not just a disclaimer.

Tapas Anyone?

The first week of November the markets had a feast of Greek dolmas (stuffed grape leaves). Greece appeared to be in a meltdown only to be revived at the end of the week. Last week the markets dined on cannoli as the collapse of the Italian bond market moved the crisis from Greece to Italy. In both cases, a change in leadership temporarily caused the markets to surge and recover the big losses that started each week. We now have two new leaders in Greece and Italy who will ultimately prove just as ineffective as the two ouster premiers. When debt problems are so overwhelming and the structural flaws of the political and financial systems are so deeply embedded it’s just a matter of time before the endgame must be played regardless of the quarterback. Once again it appears the endgame has been delayed until 2012. But with the rapidly moving scenarios playing out across Europe, the opening whistle to the endgame could blow at any time.

What’s ahead? It’s clear that no one knows. While the markets celebrated the end of the Berlusconi reign, there is no guarantee that the bond market in Italy will cooperate. The plunge in prices in Italian bonds was arrested by the change, but the debt of Italy remains in a very fragile state. The conditions that caused the bond debacle are still present; only the name on the Premier’s office changed. Unfortunately, even if Italy and Greece manage to avoid further disruptions for a few weeks, Spain could be next in line in the unlimited buffet of debt problems in Europe. The debt of Spain has been trading better than that of Italy, but the Spanish bond market is following the same pattern as Italy’s. In fact, some of the concerns about the true nature of Spain’s banking system (with potential losses unaccounted for) are more troubling than those in Italy. Tapas might be next on the menu.

The perplexing aspect of all of this is that the stock market in the U.S. is virtually unchanged on the year. While it’s always possible that the European debt crisis will be solved in an orderly fashion, it’s also not realistic. At best, the various components of the European Union bailout plan will result in a recession in Europe that will have be a drag on the global economy. At worst, the debt fiasco will end badly and result in a few weeks of market chaos and then a global slowdown.

As I’ve mentioned in the prior weeks, Wall Street traders, et al, just want to end the year in rally mode in order to bank some more bonus checks. To most of us, logic would dictate a cautious approach with some many unresolved issues ahead, but that’s just crazy talk on Wall Street. The 3^rd quarter was a terrible quarter for Wall Street and especially hedge funds (big accounts that take big risks with borrowed money). Most of us would be reluctant to take on more risk after that experience. But these guys play a different game – big risk for big reward. There is no middle ground. What some recent numbers and anecdotal information have revealed is that hedge funds actually ramped up risk after that the 3^rd quarter debacle. Wall Street mavens are saying that the market has taken on all the bad news and remains unshaken, and this means the market is a “buy.” Perhaps. But, it could also mean that the market is an illusion if not delusional and not at all reflecting any future outcome other than the optimal.

While Europe has been and will continue to be the dominant force, our own economy continues to chug along at a sluggish pace. We should get more evidence of that this coming week. You will be reading about Housing Starts, Retail Sales, Industrial Production, and the Consumer Price Index. All of these should reflect an economy that is cautiously moving ahead. As mentioned in last week’s column, businesses are being cautious in these uncertain times. The pace of economy and level of business and consumer confidence reflect more an appropriate response to the events this year and the risk ahead. Wall Street’s throw-caution-to-the-wind attitude is fine for the big, short-term risk takers, but that attitude doesn’t work for those in it for the long haul.

For some of you the last few weeks (months) of volatile trading has led to several bouts of indigestion. As I’ve said before, the real test of whether or not you have the right investment mix is whether you can sleep at night. It’s really hard to get a good night’s sleep if you have indigestion. Delusional or not, the market continues to give you opportunities to think long-term about your needs and whether or not your current investment profile is really right for you. Eating at an all-you-can-eat buffet when your system can’t handle it is bad for your health.

 

The following are some thoughts I had on the markets Thursday and Friday, which I posted on my service web site. At the end I added my two cents on the S&P downgrade.

After an absurd day with a 400 point swing in the Dow, the Dow closed with a gain of   points 61 points. The S&P closed almost unchanged and just decimal points below 1200. The NASDAQ closed down 1%. Volume was huge! (Read updates for reasons) For the week the Dow closed lower by 700 points. At the beginning of the week, with the debt ceiling bill passage, I reminded everyone that after the 2008 TARP passage the Dow was 1,000 points lower thirty days later. At the low this morning, the Dow was in fact down 1,000 points in just one week. The S&P lost 7% this week, and the NASDAQ gave up 8%. The all-important Nonfarm Payroll number was forgotten after the first 15 minutes of trading.

A day like today makes you want to sell every stock you own and never buy stocks again. We have some serious problems, but I’ll just give you two. First, the credit crisis in Europe will eventually overtake everything. If the EU follows through with bond purchases next week the crisis will be postponed but remain inevitable. They have no long-term answers, and their short-term answers have shrinking credibility. It’s like tossing doggie bones at traders. Stock trading today alone tells you this will be a problem for the market. The Dow went from +170 to -230 at least partially on Europe. The news of purchases caused the Dow to go from -230 to +150 points. That ain’t right folks. Plus, at least half of the entire recent downturn in stocks was Euro based. Money was fleeing European banks, and my bet is that we haven’t seen the last of that.

Second, high frequency traders have not gone away. We haven’t heard much about them as they pulled back after some scrutiny. They were obviously still lurking on the street corner. While most of the activity today was from leveraged traders who were forced to sell and from big bargain hunters, we saw instantaneous 100 point swings. That can only come from those high frequency computers. One of these days, those computers might get stuck on the sell signal. The economy is the least of our worries.

No one knows what we’ll walk into Monday. European markets were closed when the news of the bond purchases broke. Those markets should open up huge. But, if European traders get any whiff over the weekend that the bond purchase plan is not completely credible, the markets could be in a freefall. What a choice.

 

If I ruled the world (I’ll be happy to just start with the U.S.), I would tell everyone “Get a grip!” Every television and radio newscast, website, newspaper etc. led Thursday night with dire stories of the stock selloff. The most common headlines were “America in Crisis” and “Global Meltdown.” Hey, so stocks have sold off for a few days. Big deal. In the U.S., the markets are down just slightly on the year. Many of the articles written said that governments needed to do something to avert another recession. Really. Is that what you want? Government and central bank tinkering has done nothing but put band-aids on wounds that need open air to heal.

This hardly qualifies as a crisis. More importantly the economy isn’t in crisis either. Yes, the economy has slowed, but we’re not burning up jobs at 500,000 jobs per month, and our financial institutions aren’t under attack. The stock market was simply breathing thin air and living on QEII money, and traders weren’t thinking clearly. Leverage amplified everything. Now, some of that has come out. Could it get worse? Yes. And I believe there will be a “real” crisis sometime in the next twelve months in Europe, but I don’t believe this will lead to another economic meltdown in the U.S. The economy will slow again and stock prices will fall. This is just the cycle we’re stuck in. Relax.

Finally, a couple of thoughts on the S&P downgrade. First and foremost, this will mean nothing to interest rates for a variety of reasons. Frankly the world cannot do without our huge market to use as a giant liquidity pool. Plus, where the heck would they put all those dollars they have? Rates will move on fears or lack thereof, economic conditions, and inflation. The world knows we can pay our debt. We have a printing press.

Second, S&P is looking pretty dumb on this one – even dumber than usual. These are the same guys who never saw the mortgage crisis coming. While that is their most spectacular failure, the history books are littered with corporations and municipalities that S&P had highly rated just before the entities dove for the cheap seats. The S&P also admitted they had missed estimates by $2 trillion, but that made no difference to them. They ended up claiming the big reason was they didn’t like our political atmosphere after witnessing the debt ceiling fiasco. Well who does! No one. But it’s hardly S&P’s place to base financial analysis on their limited view of politics.

S&P also rates France AAA, but it’s clear to everyone that France’s own social program costs will be much worse than ours in the years ahead. They have the Germany and France AAA although those two will be taking huge hits on Greek debt et al, as Germany and France are the primary funding source of the ECB purchases of bad debt. And, by the way, S&P still rates Italy and Spain AA although their numbers are looking more like junk bonds. S&P seemed determined to make a political statement regardless of facts. I don’t like our fiscal outlook either, but I know the U.S. will pay although the process of getting there is ugly.

S&P needs to take a hard look at itself and clean up its own house before it gossips about the U.S. having the messiest house on the block.