Tuesday, 3 January 2012

Me and Ze 2012 Outlook & Strategy

I hope everyone had a great holiday weekend and are ready to start some serious contemplation about our investment strategy for next year. There is nothing earth shattering about this approach since I have laid the groundwork for the basic plan through regular commentary on  Yet still there is often a benefit in putting all the dots together in one place to see the full picture. That is what we will do today.
Economic Outlook
Even with the recession scare from the summer, it very much looks like the Muddle Through Economy for the US continues to stay on course. That is where we have positive GDP growth for the nation. It just never gets above the traditional 3% level we are used to relating to a healthy economy.
And yes, this is the same level of modest GDP growth that we have seen for the last two years which was good enough to keep corporate earnings on the upswing, and good enough to attract investors to stocks.
What About Europe? 
People have to separate a European slowdown from a European implosion. It appears to me, and a growing number of experts, that the Europeans have done enough to fend off the “Lehman” type implosion that would have rocked the world’s economy. Instead, they will likely go through a modest recessionary period as their nations take the austerity medicine that will make them stronger in the future.
(For more insight on my view of Europe, then http://mezecm.blogspot.com
Simply a European recession does not derail the US economy and our Muddle Through Scenario stays on track.
What About China?
No nation can grow at 8-10% forever. So there is nothing naturally ominous in the fact that their growth is slowing at this time. Too many investors are taking this as a case that China will go through a deep recession. That is possible, but not probable at this time. Especially because China has AMPLE stimulus at the ready to keep their economy going if need be.
We should continue to keep an eye on this situation because any significant decline in their ravenous demand would have negative consequences for the world economy. I just think they are more likely to grow at 3-5% in the near future versus going into a recession.
Outlook for US Stocks?
As noted above, I expect the US economy to continue to Muddle Through and that is good enough for corporate earnings growth. Right now earnings projections for the S&P 500 next year are around $106 per share. That means the market is only trading at a paltry PE of 12. Well below the historical norms of 14-15.
Now consider your alternatives. The 10 year bond only pays 2%. And shorter term cash instruments like CD’s, money markets etc pay next to nothing. Real estate is dicey at best. And the allure of gold and silver has tapered off. Add it all up and stocks remain the best game in town.
As people worry less about Europe and China then it will create a tractor beam pull towards stocks. I can easily see the market getting to 1400 on the S&P 500 which equates to a PE of just 13.2.
Why not higher if the historical norm is a PE of 14-15? Because Muddle Through Economic growth means lower than normal earnings growth and that should be accompanied by a lower than normal PE. However, if the pendulum switches from fear to greed, and bond/cash yields remain low, then touching 1500 is not out of the question.
Portfolio Strategy
Just because I am looking past Europe and China doesn’t mean the rest of the investment community is in full agreement. Nor does it guarantee that it will play out as smoothly as I might hope.
So I suspect that a lot of the volatility of the last several months will be in place for the beginning of 2012 as well. That is why I am not advocating a 100% long portfolio strategy at this time. Yet we are clearly on a path towards that posture as those dark clouds disappear.
I think the groups that will do the best in 2012 are the ones that did the worst in 2011. And those are cyclical and growth oriented groups that got pounded down when the recession fears took hold. This also means that the defensive positions that served us well in 2011 will underperform if people become less risk adverse as they are now.
Hope for the Best. Prepare for the Worst
Yes, I am putting my money where my mouth is with this forecast. But I also realize that what lies ahead may be very different from what I just described and my strategy would adjust accordingly.
Gladly I am not an investor who falls in love with their predictions and becomes paralyzed when the facts change. I stay open to all possibilities and will invest based upon the preponderance of the evidence. And thus I recommend that you do the same. In the meantime, I like the odds of more upside for stocks for all the reasons noted above. . 

Wishing You All a Happy, Healthy & Profitable New Year.

Me and Ze Capital Mnagement

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