GSA 2012 Outlook
As we exit 2011 I’m reminded of the season finale from the television series Dallas. After a whole season of treachery, cheating, back stabbing, love and hate we learn it has all been one long bad dream for Larry Hagman. This year’s markets have experienced it all. We look for 2012 to be the awakening. But, first let’s review.
GSA’s outlook for 2011 went unfulfilled. Earnings came in better than projected, however the earnings multiple afforded the superior growth rates and earnings actually contracted instead of expanding to the historical norm. We don’t take it lightly, but a miss is a miss and we own it. We listed four major risks:
1. Political. The inability of the mainstream Republican Party to find common ground with the tea party faction cost the US its AAA rating. This nearly triggered a credit default event and double dip recession due to consumer angst.
2. Sovereign debt default. We warned about the necessity to be aggressive and progressive abandoning the reactive posture the EU memberships had taken thus far. We warned of a potential 20% haircut on Greek debt of which we were too conservative. It turns out it will be a 50% or greater scalping. Meaning holders of Greek treasury bonds will receive .50 for every $1 they own. The EU membership and ECB never took the necessary pre-emptive steps to fend off the bond vigilantes. Thus the battle lines are now drawn squarely around Italy. This will prove to be the European Union’s Lehman moment. Less talked about, in GSA’s assessment the ECB just went all-in with their latest 3 year term loans program. Step 1. Lending out unlimited Euro’s to the Euro banks. Step 2.The banks can in turn buy Sovereign debt. Step 3.They can use this debt as collateral at the ECB for additional funding. Sound familiar?
3. Inflation. The current benign inflationary period we are enjoying (for those of us that don’t eat, heat our homes or drive) was threatened over the summer when gasoline spiked above $4. The effect on consumer psyche and in turn spending choked off retail sales momentum to near recessionary levels. The stopped clocks (analysts preaching same story ad infinitum waiting to be proven correct) resurfaced en-masse. In short time and with renewed confidence the calls for a super spike in oil and gas came along with the rehash of the useless Peak oil theory. Then Ghadaffi was ousted and Libyan oil began to flow again. Natural gas fracking unleashed enormous amounts of both domestic gas and oil. This deflated the price of Natural gas below $3 and held oil in check below $100. For now.
4. A failed US treasury auction. Not even close here. The US lost its AAA rating and auctioned off a staggering amount of new debt at record low rates. There was in some instances unprecedented demand. The flight to safety trade was incredibly impressive.
We batted .750% and didn’t win the World Series. Our projections were undermined by severe skepticism of global politicians’ backbones and willingness to do what was right and necessary for their respective countries. The US was front and center. Politicians need to do what is necessary vs. worrying about keeping their jobs which in times such as the ones we live in, may prove to be at odds with one another. We were further hamstrung by the collapse of MF Global just as the market was regaining its footing and recovering from the summer Washington political stalemate. Instead of gaining confidence from dramatically improved balance sheets, increased optimism from an improving jobs market and year over year gains in revenues and earnings resulting in a historical P/E or P/E v G we actually witnessed the opposite and the market multiple contracted. The prevalent negative sentiment resulted in investors pulling monies from equity markets globally. In closing, we would like to wish a happy retirement to ex-ECB President Jean Claude (Sleepe’) Trichet, have fun second guessing your successor. Ex-Greek Prime Minister Papandreau, enjoy the two-for-one dolmathes coupons I sent. Ex-IMF chief Strauss-Kahn, lay off the hotel staff. Ex-MF Global CEO Corzine, go back to politics. Finally Ex-Italy PM Berlusconi, now you’ll have plenty of time for your other girl friends. I think I was a teenager living in Rockaway Beach, NY one summer on a bad streak the last time I had this many ex’s in one year. But, in this case anyway I can almost guarantee I’ll be a better person without them.
We’ll look at a few potential major risks to 2012:
Iran. The global community is seemingly finally united in confronting Iran’s nuclear ambitions. Their solution, hit ‘em where it hurts, in their purse. New sanctions on the Iranian Central Bank have prodded Iran to respond with threats of closing the Straits of Hormuz which sees roughly 17 million barrels of energy pass through daily. Should there be an all out blockade we’d most likely see a super spike in oil crippling consumer discretionary spending, at a minimum. The next escalation would mostly be a full blown strike on Iran by the US or Israel. We look forward to the day the Middle East can patrol and protect themselves.
China. The soft landing currently anticipated turns out to be more of a crash which sets off riots among the populace.
The European Union. The EU membership is unable to come to consensus on fiscal policy and backtracks from any rescue package. Greece abruptly exits the EU, followed by Portugal triggering credit events that force EU financials to pay on outstanding CDS contracts punching huge holes in their balance sheets as the credit markets slam shut for new funding to fill those gaps causing cascading defaults, a run on the banks, Italy being frozen out of the credit markets and finally the ultimate destruction of the Euro as a whole.
The Good ole’ US of A. (A) The US economy, fueled by a rejuvenated job market producing 250,000+ new jobs per month allowing for an even greater increase in consumer spending. This light the inflation fuse, the Federal Reserve must adjust policy before previously planned, pushing up sharply borrowing costs across the spectrum. The nascent housing recovery is stifled. The US dollar spikes, reducing our export advantage our current dollar exchange rates affords US multinationals.
The Good ole’ US of A (B). The US “leadership” remains severely partisan and divided in the face of ballooning entitlement programs and we experience another summer of 2011 resulting in an almost inconceivable and insurmountable second ratings downgrade. This second downgrade should cause global investors to seek in earnest another more fiscally responsible safe haven for the monies. This should cause a spike in US borrowing costs and potential QE III which would begin the swirling of the toilet bowl.
Projection:
Global Monetary policy remains highly accommodative. The US Federal Reserve has pledged to maintain the zero interest rate target until mid 2013 and may extend the date if necessary. The European Central Bank under New leadership from Mario Draghi has gone all-in with its offering of unlimited liquidity in the form of 3 year loans at 1%. My concerns surrounding the end of such policies and Quantitative Easing in general as such, are not of a concern for 2012 obviously.
The EU membership has finally begun to work toward fixing their balance sheets. In some cases draconian cuts in social services, downsizing the government work force and reshaping the local labor laws are being fought tooth and nail by the union membership as well as those on the receiving end of these all too generous unsustainable programs. For any of these austerity measures to be successful they must have a growth counterpart. All they need do is look to Ireland as a model of success, which just returned to positive GDP expansion, albeit modest. After a decade of over borrowing and spending beyond their means the EU membership are finally dealing with this debt and spending largess. In the end it may be years before these issues are resolved and they are on firmer footing, but the mere presence of a sound plan should be enough. The Euro-zone economy is expected to dip into a recession in the first quarter of 2012 and end the year modestly positive 1% with Germany and France doing the heavy lifting.
China has hit a slow patch. The dissipation of the inflationary clouds should allow for the stimulus spigots to get turned back on and help this behemoth regain its footing. This managed economy’s plan of build it and they will come has resulted in ghost cities and put strains on their domestic banking system. Doubters need only look to Shanghai as turning out to be just such a success the Chinese leadership hang their hats on. We’ll also continue monitoring how the shift towards a more balanced economy, one of manufacturing and services unfolds. Further, the push to foster domestic consumption is an ongoing story that has made for a good read with reasonable success. The economy is expected to expand at a modestly slower than norm, but enviable rate of 8 ½%.
India heal thy self. Elevated levels of domestic Inflation forced the central bank to hike rates even as the economic growth eased. India needs to reform its tax code and reintroduce a strengthened anti-corruption legislation. Passing this stronger more broad based anti-corruption legislation along with opening the doors for further foreign capital investment should allow the Indian markets to help regain the confidence of investors and capital flows. Like China this country has over 1 billion folks that continue to migrate towards urban living and ultimately become consumers of US goods. The domestic economy, likewise expands a bit slower than last but at an enviable 6 ½-7% rate.
The US economy continues to be exceptionally resilient DESPITE Washington. The ISM Manufacturing Index just released came in +53.7, better than expected, with a strong jobs component and new orders index embedded within. The Leading Economic Indicator increased .05 in November on top of +.09 the prior month. Housing start rose 9.3% in November while permits were a strong +5.7% both highs not seen since March and April of 2010. Perhaps a sign of a bottoming process in housing taking place. The jobs front continues to make gains with this upcoming Friday’s Non-farm payroll number expected to come in a healthy 175,000-200,000. I will look more closely at the household jobs figure to come in +350,000-400,000. as this figure captures small business and self employed not counted in the more popularly reported Non-Farm Payroll number. Capital spending has been robust, exports are exploding, with the US about to be a MAJOR exporter of OIL and GAS. We couple these with virtually pristine balance sheets of non-financial corporations and fortress like balance sheets of the major financials allowing us to be cautious but certainly optimistic for 2012. We see S&P 500 earnings coming in conservatively $106 and due to the pessimistic overhang coming into the year a below historical average market multiple of 13 ½-14 to come up with our year end target range of 1431-1484. Volatility should remain the stubborn family member that refuses to go home after the holidays are over. We may see a strong move above our year end target and brute selling that will test the metal of investors yet again. Should confidence grow the EU has a formidable plan to handle the debt crisis that gripped headlines the last few years along with US politicians making progress with a credible deficit reduction plan our targets may prove to be too conservative.
We maintain our aggressive, balanced investment posture entering 2012 but remain on heightened alert for any setbacks to the EU debt issues and domestic jobs creation front and center. Should the economic environment retrace from the progress already made or the EU hit crisis mode, yet again, we’ll be quick to reassess our cash position and be in contact immediately and act accordingly.
We thank you for your patience and confidence in these extremely challenging times.
Yours in search of the Kwan!
GSA’s outlook for 2011 went unfulfilled. Earnings came in better than projected, however the earnings multiple afforded the superior growth rates and earnings actually contracted instead of expanding to the historical norm. We don’t take it lightly, but a miss is a miss and we own it. We listed four major risks:
1. Political. The inability of the mainstream Republican Party to find common ground with the tea party faction cost the US its AAA rating. This nearly triggered a credit default event and double dip recession due to consumer angst.
2. Sovereign debt default. We warned about the necessity to be aggressive and progressive abandoning the reactive posture the EU memberships had taken thus far. We warned of a potential 20% haircut on Greek debt of which we were too conservative. It turns out it will be a 50% or greater scalping. Meaning holders of Greek treasury bonds will receive .50 for every $1 they own. The EU membership and ECB never took the necessary pre-emptive steps to fend off the bond vigilantes. Thus the battle lines are now drawn squarely around Italy. This will prove to be the European Union’s Lehman moment. Less talked about, in GSA’s assessment the ECB just went all-in with their latest 3 year term loans program. Step 1. Lending out unlimited Euro’s to the Euro banks. Step 2.The banks can in turn buy Sovereign debt. Step 3.They can use this debt as collateral at the ECB for additional funding. Sound familiar?
3. Inflation. The current benign inflationary period we are enjoying (for those of us that don’t eat, heat our homes or drive) was threatened over the summer when gasoline spiked above $4. The effect on consumer psyche and in turn spending choked off retail sales momentum to near recessionary levels. The stopped clocks (analysts preaching same story ad infinitum waiting to be proven correct) resurfaced en-masse. In short time and with renewed confidence the calls for a super spike in oil and gas came along with the rehash of the useless Peak oil theory. Then Ghadaffi was ousted and Libyan oil began to flow again. Natural gas fracking unleashed enormous amounts of both domestic gas and oil. This deflated the price of Natural gas below $3 and held oil in check below $100. For now.
4. A failed US treasury auction. Not even close here. The US lost its AAA rating and auctioned off a staggering amount of new debt at record low rates. There was in some instances unprecedented demand. The flight to safety trade was incredibly impressive.
We batted .750% and didn’t win the World Series. Our projections were undermined by severe skepticism of global politicians’ backbones and willingness to do what was right and necessary for their respective countries. The US was front and center. Politicians need to do what is necessary vs. worrying about keeping their jobs which in times such as the ones we live in, may prove to be at odds with one another. We were further hamstrung by the collapse of MF Global just as the market was regaining its footing and recovering from the summer Washington political stalemate. Instead of gaining confidence from dramatically improved balance sheets, increased optimism from an improving jobs market and year over year gains in revenues and earnings resulting in a historical P/E or P/E v G we actually witnessed the opposite and the market multiple contracted. The prevalent negative sentiment resulted in investors pulling monies from equity markets globally. In closing, we would like to wish a happy retirement to ex-ECB President Jean Claude (Sleepe’) Trichet, have fun second guessing your successor. Ex-Greek Prime Minister Papandreau, enjoy the two-for-one dolmathes coupons I sent. Ex-IMF chief Strauss-Kahn, lay off the hotel staff. Ex-MF Global CEO Corzine, go back to politics. Finally Ex-Italy PM Berlusconi, now you’ll have plenty of time for your other girl friends. I think I was a teenager living in Rockaway Beach, NY one summer on a bad streak the last time I had this many ex’s in one year. But, in this case anyway I can almost guarantee I’ll be a better person without them.
We’ll look at a few potential major risks to 2012:
Iran. The global community is seemingly finally united in confronting Iran’s nuclear ambitions. Their solution, hit ‘em where it hurts, in their purse. New sanctions on the Iranian Central Bank have prodded Iran to respond with threats of closing the Straits of Hormuz which sees roughly 17 million barrels of energy pass through daily. Should there be an all out blockade we’d most likely see a super spike in oil crippling consumer discretionary spending, at a minimum. The next escalation would mostly be a full blown strike on Iran by the US or Israel. We look forward to the day the Middle East can patrol and protect themselves.
China. The soft landing currently anticipated turns out to be more of a crash which sets off riots among the populace.
The European Union. The EU membership is unable to come to consensus on fiscal policy and backtracks from any rescue package. Greece abruptly exits the EU, followed by Portugal triggering credit events that force EU financials to pay on outstanding CDS contracts punching huge holes in their balance sheets as the credit markets slam shut for new funding to fill those gaps causing cascading defaults, a run on the banks, Italy being frozen out of the credit markets and finally the ultimate destruction of the Euro as a whole.
The Good ole’ US of A. (A) The US economy, fueled by a rejuvenated job market producing 250,000+ new jobs per month allowing for an even greater increase in consumer spending. This light the inflation fuse, the Federal Reserve must adjust policy before previously planned, pushing up sharply borrowing costs across the spectrum. The nascent housing recovery is stifled. The US dollar spikes, reducing our export advantage our current dollar exchange rates affords US multinationals.
The Good ole’ US of A (B). The US “leadership” remains severely partisan and divided in the face of ballooning entitlement programs and we experience another summer of 2011 resulting in an almost inconceivable and insurmountable second ratings downgrade. This second downgrade should cause global investors to seek in earnest another more fiscally responsible safe haven for the monies. This should cause a spike in US borrowing costs and potential QE III which would begin the swirling of the toilet bowl.
Projection:
Global Monetary policy remains highly accommodative. The US Federal Reserve has pledged to maintain the zero interest rate target until mid 2013 and may extend the date if necessary. The European Central Bank under New leadership from Mario Draghi has gone all-in with its offering of unlimited liquidity in the form of 3 year loans at 1%. My concerns surrounding the end of such policies and Quantitative Easing in general as such, are not of a concern for 2012 obviously.
The EU membership has finally begun to work toward fixing their balance sheets. In some cases draconian cuts in social services, downsizing the government work force and reshaping the local labor laws are being fought tooth and nail by the union membership as well as those on the receiving end of these all too generous unsustainable programs. For any of these austerity measures to be successful they must have a growth counterpart. All they need do is look to Ireland as a model of success, which just returned to positive GDP expansion, albeit modest. After a decade of over borrowing and spending beyond their means the EU membership are finally dealing with this debt and spending largess. In the end it may be years before these issues are resolved and they are on firmer footing, but the mere presence of a sound plan should be enough. The Euro-zone economy is expected to dip into a recession in the first quarter of 2012 and end the year modestly positive 1% with Germany and France doing the heavy lifting.
China has hit a slow patch. The dissipation of the inflationary clouds should allow for the stimulus spigots to get turned back on and help this behemoth regain its footing. This managed economy’s plan of build it and they will come has resulted in ghost cities and put strains on their domestic banking system. Doubters need only look to Shanghai as turning out to be just such a success the Chinese leadership hang their hats on. We’ll also continue monitoring how the shift towards a more balanced economy, one of manufacturing and services unfolds. Further, the push to foster domestic consumption is an ongoing story that has made for a good read with reasonable success. The economy is expected to expand at a modestly slower than norm, but enviable rate of 8 ½%.
India heal thy self. Elevated levels of domestic Inflation forced the central bank to hike rates even as the economic growth eased. India needs to reform its tax code and reintroduce a strengthened anti-corruption legislation. Passing this stronger more broad based anti-corruption legislation along with opening the doors for further foreign capital investment should allow the Indian markets to help regain the confidence of investors and capital flows. Like China this country has over 1 billion folks that continue to migrate towards urban living and ultimately become consumers of US goods. The domestic economy, likewise expands a bit slower than last but at an enviable 6 ½-7% rate.
The US economy continues to be exceptionally resilient DESPITE Washington. The ISM Manufacturing Index just released came in +53.7, better than expected, with a strong jobs component and new orders index embedded within. The Leading Economic Indicator increased .05 in November on top of +.09 the prior month. Housing start rose 9.3% in November while permits were a strong +5.7% both highs not seen since March and April of 2010. Perhaps a sign of a bottoming process in housing taking place. The jobs front continues to make gains with this upcoming Friday’s Non-farm payroll number expected to come in a healthy 175,000-200,000. I will look more closely at the household jobs figure to come in +350,000-400,000. as this figure captures small business and self employed not counted in the more popularly reported Non-Farm Payroll number. Capital spending has been robust, exports are exploding, with the US about to be a MAJOR exporter of OIL and GAS. We couple these with virtually pristine balance sheets of non-financial corporations and fortress like balance sheets of the major financials allowing us to be cautious but certainly optimistic for 2012. We see S&P 500 earnings coming in conservatively $106 and due to the pessimistic overhang coming into the year a below historical average market multiple of 13 ½-14 to come up with our year end target range of 1431-1484. Volatility should remain the stubborn family member that refuses to go home after the holidays are over. We may see a strong move above our year end target and brute selling that will test the metal of investors yet again. Should confidence grow the EU has a formidable plan to handle the debt crisis that gripped headlines the last few years along with US politicians making progress with a credible deficit reduction plan our targets may prove to be too conservative.
We maintain our aggressive, balanced investment posture entering 2012 but remain on heightened alert for any setbacks to the EU debt issues and domestic jobs creation front and center. Should the economic environment retrace from the progress already made or the EU hit crisis mode, yet again, we’ll be quick to reassess our cash position and be in contact immediately and act accordingly.
We thank you for your patience and confidence in these extremely challenging times.
Yours in search of the Kwan!
posted by James | 10:55 AM
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