Welcome to the December 2011 edition of Views from the Crows Nest, which doubles as our 2012 Annual Forecast issue. Your author took an unplanned break from publishing for November. The bottom line is that we were so busy with client meetings across western Canada and ongoing market research that there simply wasn’t time available.
Our 2011 Annual Forecast created quite a stir, with many readers remarking that your author’s view of the world seemed unrealistically dark and pessimistic. Unfortunately, the majority of the risks we identified either contributed directly to extreme market volatility, or have at least continued to worsen on the periphery. There are two kinds of people in the world: people with too much class to say “I told you so,” and people like me. That being said, there is negligible pleasure in being correct about negative situations.
Our Annual Forecast is typically a lengthy missive requiring 35 to 40 hours of your author’s time. The 2012 edition will focus more on conclusions, rather than lengthy passages explaining the reasoning and intuitions behind our conclusions. Until I perfect my quantum jumping skills, brevity will prevail – perhaps a blessing with a thin disguise?
In a nutshell, your author is bullish for nimble client portfolios is 2012. My contrarian optimism is based on how thoroughly challenging 2012 is likely to be. There are so many serious risks that could create exceptional market volatility – much worse than 2011 – that many money-making opportunities will arise…going in both directions. Great things happen when resistance to trend is minimized, so just go with the flow.
In the 2011 Annual Forecast, your author ranked our portfolio managers’ 2010 performance at 8.25 out of 10. Active managers add value when they generate (net-of-fees) performance that is a) roughly equivalent to the benchmark but with lower volatility, b) higher than the benchmark with similar volatility, or c) higher return and lower volatility than the benchmark. c) is the sweet spot for managers.
At time of publishing, the S&P 500 is just below break-even for the year, and the S&P TSX looks like it will finish down about 11 or 12%. The broad Emerging Markets are still down over 18%, and European stocks look poised to finish at about -14%. Final audited results will take about 5-6 weeks to calculate, but overall estimates for our global portfolios show that our client portfolios are perhaps 1-1.25% below the S&P 500 but with about half the volatility, and 9 to 10% above the TSX with less than half its volatility. Overall, our managers definitely delivered value to clients in what was an exceptionally tough year to manage money.
Our managers also out-performed the vast majority of hedge fund managers in the U.S., which is no small feat. We are keenly aware that clients always prefer big positive returns regardless of the market environment. Few managers on the planet deliver such results consistently, though our team definitely aspires to this. We have exceptionally high internal expectations, and recognize that we can’t please everyone all the time. This year’s grade for our team: 8.75 out of 10.
Looking forward, 2012 is likely to be a year of extremely significant change on many different levels. The world’s financial system faces yet another series of crises that cannot be magically contained by central planners’ sophistry, increased “co-operation” and financial engineering. For those investors who continue with the buy and hold strategy, 2012 will likely prove to be a gut-wrenching experience. Sadly, some may finally throw in the towel near a bottom and seek the false safety of longer term GIC’s etc that will eventually confiscate their purchasing power as price inflation continues to rise.
In contrast, our portfolio management team is pleased to ride whatever is left of the current uptrend in equity markets. They patiently await the inevitable volatility ahead, ready and willing to harmonize client accounts with whatever symphony the markets care to play. There’s always a bull market somewhere…and our managers are open to whatever asset classes show the best potential for growth and/or safety at any given time.
The Chinese word for crisis contains two elements: danger andopportunity. While 2012 promises to deliver significant downside volatility – danger for most investors – the equity downtrend itselfparadoxically creates upside opportunity for those willing to seek early safe haven in bonds and growth in Inverse equity ETF’s. Markets are really instantaneous barometers of investor emotion and always over-shoot to the downside; thereby creating a second opportunity for more gradual growth following major declines. It’s all about the attitude one brings to the battlefield.
Okay, so we’re optimistic about investment results in 2012 specifically because of our projections of extreme volatility. Though there are probably others, your author discerns five major risk (and reward) themes next year:
1) The US Economy. With some recent economic data points being somewhat less bad, the latest fantasy pumped by the perma-bulls on CNBC is that the US has supposedly “de-coupled” from the rest of the world. Frankly speaking, “de-coupling” is “bull.” The best the Americans can hope for is a lag to other markets. The US is still massively over-indebted at the household and governmental level, and this simply must be dealt with by de-leveraging virtually every aspect of the economy back to sustainable levels. This will likely take another 4 to 10 years, with significant market volatility likely to begin by the end of Q1 2012, or very shortly thereafter. The S&P 500 has significant downside, as legendary value manager Jeremy Grantham has explained.
2) The Eurozone’s Debt Problems. Here’s a potential script for a Saturday Night Live parody of private meetings during the endless parade of Eurozone Summits: “Hey, let’s try to fix a bureaucratic, socialist, debt-drenched political experiment with more bureaucracy, more socialism and even higher levels of increasingly complex forms of indebtedness…all while forcing member countries to surrender the last vestiges of national sovereignty.” This is the essence of the path that Europe is on, though such public candour would never happen. Kyle Bass provides an exceptionally well-researched and articulate explanation of why Europe (and Japan) cannot escape without massive de-valuation. The UK appears intent on maintaining control of its own printing presses, and the results are predictable so far: “stagflation” or “infression” – an inflationary depression.
3) A Hard Landing in China. Building empty apartments, shopping malls and even cities may add to GDP, but even in China these missteps must be paid for. The other crumbling pillar of Chinese GDP is manufacturing for export…to broke countries. Jim Chanos explains.
4) War with Iran. For over a year, we have been increasingly concerned about a full scale military conflict involving Iran, the US and Israel. The probability increases daily, with each player raising the stakes at the first opportunity. With a US Presidential election in just over 10 months, low domestic political approval ratings for Iran’s leadership, recent US troop withdrawals or reductions in Iraq & Afghanistan and persistently high US unemployment, a full scale military skirmish with a country that may have (nuclear) Weapons of Mass Destruction seems increasingly probable. The US Navy’s 5th Fleet is based in Bahrain, and there is currently a second carrier battle group (CVN John Stennis) in the Gulf of Oman and the rhetoric is rising with the tensions. Continued revolution in neighbouring Syria could also be used to manipulate Iran into firing the first shots to provide the political “justification” for a joint strike on Iran. If Iran hated Israel & the US or actually had oil I might be suspicious about the purity of the US/Israeli coalition’s intentions. At this very moment, Canadian oil doesn’t seem quite as “dirty” as Darryl Hannah, Robert Redford and friends seem to believe it is.
5) Increased interference by central planners. Everywhere you turn, someone is calling for a government agency of some kind to get someone out of a bind that never should have happened in the first place. Like the frog in the pot of cold water that sits ever-so-innocently on the back burner, most of the world is blind to the accelerating pace of intervention by powerful alliances of government and corporate interests. In our fractional-reserve fiat-currency system, the only catastrophic outcome for the elite is deflation, so they do everything possible to avoid it, including covert expansion of the monetary bases in the US and also in Europe. In the economic arena, the results are consistent: privatize the profits but socialize all the losses. In our daily lives the theme is: surrender your freedoms gradually in pursuit of perceived safety; we’ll protect you. Remember, governments NEVER create wealth; they only re-distribute it inefficiently and subjectively to their friends…and they can’t print gold or silver. Have a dose of smelling salts to clear your head.
As we see things developing, strength in equity markets might last through the end of Q1 2012. Then one of the first four risk themes listed above will likely start to overwhelm rising price patterns. The depth and intensity of market declines that follow will be determined by how many of these four catalysts explode in a short period of time…or an exogenous Black Swan that shows up to surprise everyone. This should lead to a significant recovery in the second half of 2012.
We also recognize that amidst all of the obvious risks there exists an outside chance of markets rising higher and longer than we currently anticipate. There are many big rocks in this wall of worry, and much stranger things have happened. The great blessing is that we do have a clear-headed, non-subjective standard to follow. As we are fond of saying, “In investing, price is the only objective truth; all else is opinion.” Our managers always keep this principle top of mind, lest ego (“being right”) clouds fiduciary responsibility (“getting it right” for clients). Ride the major trend, don’t fight the tape, and go with the flow.
As far as strategy and tactics go, we hearken back to our 2011 Annual Forecast:
1) Get your house in order: maximize employment income and savings, rationalize your lifestyle, pay off debt as rapidly as possible, educate yourself, and understand your own limitations;
2) Hold investments while they are rising. Capital gains are the primary goal and yield/income is secondary. NEVER fall in love with any investment because of its income stream; stay objective;
3) Minimize losses by:
a. Diversifying across asset classes with upside and LIQUIDITY
b. Timing your purchases
c. Using stop loss orders for every single position
d. Hedging currency risk
e. Holding cash until your selected investments stop falling
f. Never being fully invested
4) Maximize gains by:
a. Tactically over-weighting your portfolio toward asset classes with greater upside potential and LIQUIDITY, especially companies with real wealth in the ground (oil, gold and silver, rare earth elements)
b. Timing your purchases
c. Not limiting the upside potential of your individual positions; ride your winners as long as they rise and only harvest your gains when your positions break their uptrend
d. Using trailing stop loss orders to protect both gains & principal
e. Never being fully invested
5) Learn about and benefit from Mass Psychology. Think critically and act nimbly. Fear, greed, envy and impatience are destructive to your wealth; patience, discipline and personal joy are accretive to both your wealth and general happiness.
6) Insure against the worst case scenario by owning some physical precious metals: bullion and/or coins. GOLD IS MONEY, SILVER IS BOTH MONEY AND AN INDUSTRIAL COMMODITY. Never store them at home, and maintain your confidentiality.
7) Actively pursue and cultivate your own personal health and happiness, including:
a. Understanding and living according to your values, beliefs and priorities;
b. Embracing an attitude of true gratitude for our prosperous and safe country;
c. Getting a thorough health assessment and addressing challenges before they develop into a crisis;
d. Sharing your knowledge of investment risks with people you care about, so they can financially protect themselves. This is good for them and you…pay it forward;
e. Getting actively involved in creating positive change where you can have maximum effect, whether it’s politics or volunteering in your community; and
f. Living compassionately, because this is living well.
If you are already a member of our Client Family, rest easy…we have you covered for points 1 to 5 above. Points 6 and 7 we all need to do for ourselves.
Fear and Greed are destructive to wealth, health and happiness; Patience and Discipline are accretive. We wish you and your family all the best in 2012.