Investors, Survive and Thrive in 2012

For many, for most, the end of a year is typically overshadowed by the hope for the New Year. Not this yearend. Many are glad 2011 is over; most are fearful about 2012.

What plagued the world politically, economically and financially in 2011 will revisit most nations and financial markets in 2012, with greater intensity. And what plagued the world in 2011 – that order of events, politics, economics, finance – will plague everyone again in 2012.

In democracies and over time in prison states like China, politics and politicians are supposed to follow the lead of the economy and its supposed servants, financial markets. Since 2007, this order has been reversed and, given the fragile state of the U.S. and world economies and the even more fragile state of equity and debt markets, it shows no sign of reverting to the Old Normal anytime soon. We are thee years into a new era of a New Normal – fractured politics, stagnant economies and volatile markets – and my point here is that it is a new era, not just a period of time. This New Normal is a new reality for investors and in 2012 investors need to accept this reality if they are to succeed in any fashion.

Madness that is more volatile, more dangerous

In 2012, this New Normal will best be characterized by a Madness of Crowds that is more instant and more volatile than in 2011. And, for those fighting it, more dangerous. This herd behavior will dominate trading in 2012 – and give investors great opportunities if they accept what the market gives them.

What will the market give investors 2012?

• A much greater ability to pick winners and losers than it did in 2011 simply because the market has learned to shrug off intraday and intraweek movements driven by Greek politicians, U.S. debt deficit negotiations, flash crashes, bankrupt commodity trading firms and the Detroit Lions making the playoffs.
• Greater volatility than we saw in 2011 as the European crisis worsens, especially in Q1. It may possibly blow out of proportion when Greece hints it may default a second time before yearend. It is supposed to default the first time in Q1.
• With a market rewarding winners and punishing losers, longer term investors can zero in on great companies and great stocks, buy them and prepare to hold with a strategy that recognizes volatility will increase.
• With a market more volatile, longer term investors will need to write calls against their holdings to generate income, to average down, to create more capital, to whatever they want to do with that cash. Speculators will be able to see faster and more profitable increases in option positions, especially put positions, as volatility creates rapid gains – and losses.

Market drivers for 2012

What will drive the market in 2012?

• Day to day, perhaps week to week, events, headlines and that herd mentality. Through the course of the year, barring a market crash, now only about a 10% possibility, fundamentals will return as a driving force behind great and terrible performers.
• What events will turn into crises that hurt the market?
1. Europe has not resolved anything and has set a March deadline for itself for a new arrangement that will enable the “group” to punish nations that spend and borrow too much. Sure, right. The U.K. will not agree to this, other nations may not agree, bond markets do not like it, and a deep recession is already set in stone, reducing tax revenues, increasing transfer payments and making current national budgets moot. The bottom line is more bond market instability and that will drive trading in equity markets around the world. The European recession will also hurt exporters to Europe, especially China and commodity exporters to China other than agricultural products.
2. The U.S. has its own problems currently masked by the holidays and the increasingly humorous rhetoric in the Republican primary contest, none of it remotely relevant to solving deficit and debt problems. The debate on extending unemployment benefits and payroll tax cuts must come to an end at the end of February. It will be somewhere between frustrating and meaningless and dangerous. Throughout 2012 electoral politics will push any real solutions aside and sometime mid-year it will become obvious that unless the right wing of the Republican party agrees to some sort of meaningful tax increase, the Bush tax cuts will expire. If Obama gets re-elected they expire. If he does not, the Dems kill it by vote or filibuster in the Senate, they expire. The market has yet to fully price this in. In 2012 other ratings agencies will downgrade U.S. debt, the world will shrug and Treasurys will do well given problems in Europe, the U.K. and Japan.
3. Any major event – a large bank failure, Iran interfering with military force in Iraq, an Islamist coup in Pakistan – will hit markets very hard; they are very fragile.
• What events will turn into positive headlines that help the market?
1. The direct intervention of the European Central Bank (ECB) to support bond markets in a very large way in Europe. The ECB did so indirectly last week, lending more than half a billion dollars to banks who are expected to use some of this to buy sovereign debt. The market liked it and direct intervention, which means Germany wakes up and says maybe we do have a financial crisis, would push the Dow up 1000-1500 points, at least. The problem with his event? It would be triggered by a bank failure or a large bond auction failure by Italy which would lead to a large selloff in equity markets. Probability? 20%.
2. A deficit and debt deal of at least $4 trillion over ten years, which is not really any kind of a solution but would appear to be one, would push markets up and provide a floor for the bulls. The problem with this event? Right-wing Republicans would swear they will repudiate the deal if they can get more people elected in November. Probability? 5%.
3. The Fed announcing QE III – It is going to do a QE III despite Rick Perry’s threats to do bodily harm to Ben Bernanke if he does so. The Fed will do it quietly unless there is a massive failure in financial markets. If it does it too quietly, markets will be disappointed. If the Fed does it with enough visibility, markets will stay the course. If it does it with a great deal of visibility, markets could go up 20% or more. The problem with this event? It will happen only because of a deepening recession or a large crisis in the financial markets. Probability? 75%.

The crystal ball for 2012

Here are some specific predictions for 2012.

• A very deep recession in Europe, a mild one here, very slow growth in China.
• The hope for QE III and increased liquidity buoys markets and, barring a large financial crisis, they end up no more than 15% down or 15% up by yearend, depending on the scope of a crisis and the amount of liquidity injected into the market.
• Obama wins with a larger margin than anyone could imagine right now. The market begins pricing this in – with the evaporating Bush tax cuts – midsummer. The markets yawn on election night.
• Greece announces it is prepared to exit the euro. Preparations have been made in bond markets, at banks and in national capitals for this event throughout the year.
• There is a medium-sized geopolitical crisis in the Middle East – something to with a nuclear Iran or overt anti-Israeli actions by the new Egyptian government. Oil prices spike temporarily to $130.
• Great companies will do very well.

Great companies, great stocks for 2012

And what are those companies? Think of those that prospered and/or restructured during the last recession. What do I own, right now, going into 2012?

• Apple (AAPL) – Doubled in size during the Great Recession, poised to do it again in the next four years or less.
• Amazon.com (AMZN) – This is the only online company worth owning. It’s growing more than a 30% a year; what more is there to say?
• Ford (F) – people are willing to be foreclosed before they lose their car, auto sales will increase at least 10% in 2012 after a very strong 2011.
• GM (GM) – Ditto for General Motors.
• Deere & Co. (DE) – Corn production skyrocketed in 2011, farmers are flush, exports to China are replacing lost ethanol subsidies, Chinese families will give up the new moped before they give up their new taste for higher quality chicken and pork. (Own or will own it depending on when you read this.)
• The New Frugal Winners – People shopped for quality this holiday season. That means Tiffany (TIF), Coach (COH), Ralph Lauren (RL) and Nordstrom (JWN). (I sell puts against these names.)
• Cepheid (CPHD) – The world leader in molecular diagnostics, a takeover target for someone given their increasing dominance in the market. (I am in and out of this one depending on where it is in its trading range).
• Curis (CRIS) – A highly speculative biotech (I love biotech and genomics), FDA up or down in March for a new skin cancer treatment, more than 20 clinical trials underway paid for by Roche and/or the National Cancer Institute. Extremely speculative.

Best thing in 2011 – our boys and girls came home from Iraq. Second best thing? I launched two new investment services and wrote Contrarian Profits.

Best thing in 2012 – better opportunities for investors than in 2011. So bring it on.