Grin and Bear It.
Without question, the financial markets yielded better in 2012 than what
most had believed possible at the beginning of the calendar year. At that time, embroiled in a U.S. Presidential election and ongoing turmoil
in the Middle East , many analysts would have
been happy if we simply avoided catastrophe.
Despite ruinous consequences of Greek financial restructuring and
uninspiring rhetoric coming from global central banks, the markets gave us
reason to hope that the nadir of bear market capitulation might have come and
gone.
The reason I begin this year’s message with a quite simplistic
retrospective is that at no other time in the last decade has it been quite as
instructive to look backwards as it might be to prognosticate going forwards. The likely scenarios we might expect to
unfold in 2013 are really the compelling appendices to the storylines of the
past four years. Without a back-story,
this coming year really has no self-sustaining narrative.
The reason for these anomalies lies with the
diminished role of the consumer worldwide, and his/her inability to muster
either the cash or the confidence to turn around the disruptions of our current
economic crisis. Still struggling with too much
debt and no real income growth, consumers dragged down GDP to its lowest levels
in decades, and held it down to a pace that exacerbates uncertainty surrounding
forecasts and expectations.
And yet, with all of the turmoil and body blows the economy took in 2012,
we enter 2013 with a muted sense of unrealized optimism. Several themes continue to resonate for the
longer-term. Demographics, while different
than a generation ago, are in our favor as it relates to investing and finding
the next generation of capital gains providers. There is a plethora of opportunity in biotech,
and almost no poor choices in the realm of agriculture, emerging markets,
technology, and infrastructure remediation.
As a result, I am seeing greater output from my proprietary analytics
than anytime in the last half-decade.
Expectations are rising about potential equity and sector performance.
Of course, irrespective of one’s expectations, it is always critical to
maintain a prudent asset allocation balance in one’s portfolio. At the time of this writing, several uncertainties
abound about whether we have begun a secular or cyclical recovery. Cycles evolve over time to become
trends. That said, we have, indeed,
experienced several short cycle recoveries in 2012, but whether they, in the
aggregate, have sufficient strength to recalibrate a secular bear is another
thing altogether. I do not think they have. But recalibration begins with a series of
tests, and to that effect I think we are seeing early-stage progress.
There is a smaller chance that the bear
sustains than existed before, making it more likely that we can generate
positive alpha for portfolios in 2013.
The most likely scenario, in fact, is a shallowing of the downside
influences (unemployment, inflation, fiscal tightening) and improvements in
advancing economic statistics (capital expenditures, inventories, revenue). It should not be a surprise if economic
activity accelerates during the coming year.
Absent any exogenous shocks, I am prepared to trumpet for an optimistic
economic outlook for this year.
Markets.
Globally and domestically, we are near or at significant inflection
points in earnings reversals for Consumer Non-Cyclicals, Industrials, Financials,
and Technology shares. Assuming we avoid
fiscal backsliding, investors have reason to be positive about debt reduction
and/or increases in disposable personal income.
If household income rebounds, a big “if,” there might be an opportunity
for the first signs of consumer expansion in a decade. As it is now, we have seen the best indicators
since 2008. Expanding the workforce
would be the most bullish economic indicator of all.
Across all regions, “hope for a better future” is the reason people keep
trying. That hope is paying dividends in
some emerging markets. The question is
whether the “industrialized” nations can heighten prosperity for a vast array
of their citizenry by creating new engines for opportunity. If alternative energy, bio pharmaceutical
research, agribusiness, and brick-and-mortar infrastructure redevelopment can’t
gain traction, it would not be for lack of trying or creativity.
While “emerging” sectors are poised for
leadership, there is still enormous relative strength risk in mature companies
that fail to adapt. There is very little
progress in finding or supporting compromise positions between the “have’s” and
the “have nots”. Banks continue to
stumble over their dichotomous mission statement between being cultivators of
global commerce or being profit-center equities. It’s almost certain that in their feeble efforts
to generate profits, they will accept, and usually err on, the side of their
equity holders before their customers.
All of my data indicate that while the pace of
retrenching is picking up, we are still in a precarious position relative to
historical rates of recovery. After all,
the rupturous effects of Hurricane Sandy and the contentious tone of the
election rhetoric tilt the axis of acceleration negatively. All told, the consumer is not yet fully back
in the game, financially or psychologically.
Therefore, the pace of growth, if any were to occur, will be well below
its potential or our expectations. It is
unlikely, the way the numbers are shaping up, that we can exacerbate the bear
cycle, but an era of fiscal austerity has begun and we need to find a “new
normal” of analytics that take into account the kind of earnings surprises that
previously might have derailed the system entirely.
Strategy.
Thanks to this change in mindset and analysis, we might finally be able
to see nascent signs of hope in the global economy. For example, fourth quarter (2012) spending
and “optimism” improved from previous years, not enough to declare a bull
economy but significant in numbers to allow for the first comparisons that
reach a tolerable threshold of sustainability. As this momentum widens, it might exert
influence upon a spectrum of economic sectors.
In this more optimistic scenario, legislators would be loathe to pass
laws which punish the consumer psyche.
There is a chance that fiscal and monetary policy could be catalysts for
growth rather than impediments. A “grand
bargain” saves both political parties from the wrath of consumers and,
arguably, introduces more spending into an already tepid marketplace.
Following on that path, economic expansion produces more tax revenue, as
well as accelerating employment and wages.
This might be the moment for corporate “job creators” to put their money
where their mouth is, and to release the trillions they have amassed while
awaiting the outcome of our financial crisis. Given these possible outcomes, I am betting on
the “right things” occurring, and positioning portfolios in (1)
cyclical recovery (2) emerging, but consistent, earnings performers (3)
infrastructure redevelopment and (4) demographic winners in biotechnology and
agriculture.
While multiples have fallen, then risen, on news and exogenous events,
equity valuations today are inexpensive in the long run. If anything, as bond yields have evaporated,
the most compelling case for stocks is now.
Owning bonds opens too much risk when/if rates start to rise.
Obviously, the caveat is to own equities in the right denomination to
portfolio net worth, the right sectors, and using a consistent methodology for
evaluation of purchase and sales. In
other words, wholesale equity ownership is as foolish as avoiding stocks
altogether.
A regimented metric, used consistently, is the most defensive way to play
in an extremely aggressive and volatile pool.
Historically, sector growth occurs in those equities which generate
consistent earnings by knowing their customers, managing their balance sheet,
and producing something of societal value in their community. While most conversation focuses upon
“potential,” I prefer an ongoing association with sustainable valuations that
span years, geography, and economic consequences.
Conclusion.
Most of us teeter on the edge of procrastination before succumbing to an
irrational urge to act. The data today,
however, posits a different suggestion.
While many of us have already sat on the sideline assessing our anger
and frustration over an economy run into the ground, modest reforms have
occurred which offer an inflection point opportunity. The beginnings of our allocation movement are
comparable to dipping one toe in the water.
Like it or not, we can maximize potential this year, not by avoiding the
game but by playing it with cautious optimism.
That seems to be the message of the embers we are leaving behind.
Asset
Allocation:
Equity 36%/Fixed
Income 29%/Cash 35%
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