And so another year has passed into the history books – the older I get, the faster they seem to go – and investors must again try to position their portfolios for a profitable year. It hasn’t been easy to do the last few years and this year promises to be just as challenging. The usual suspects that made last year one of the most volatile on record are still with us – Europe imploding, China crashing and the US dawdling along at sub par growth – and this year we’ll also have to deal with the daily effluent of a US Presidential election campaign. While I would like to just ignore what happens in Brussels, Beijing and Washington, it is an unfortunate fact of life that investing today requires one to keep an eye – both eyes actually – on the trolls who yank on the levers of fiscal and monetary policy. In addition to the US elections, we’ll also have to worry about French elections, Fed policy, ECB policy, Bank of China policy, a Supreme Court ruling on Obamacare, the nuclear ambitions of Iran and whether Kim (Jong Un, not Kardashian) does something really stupid. And for sure something that isn’t on that less than exhaustive list. It promises to be a very interesting year.
I’ve spent the last few weeks reading over all the market predictions for the coming year and thinking deeply about the NFL playoffs. Both exercises have produced in me a feeling of supreme confidence that I have no idea what the future holds. Will the ECB finally resort to full blown quantitative easing? Will any team be able to stop Drew Brees and the New Orleans offense? I have no idea. Will China be able to engineer a soft landing by reversing their monetary tightening of last year? Is Tim Tebow good or just lucky? Again, no clue. Predicting how the global economy will perform this year and which team will win the Super Bowl are not equally difficult tasks. Truth be told, your odds on predicting the Super Bowl are probably better by a considerable margin.
Our Chief Economist, John Chapman, has produced a thoughtful piece laying out his expectations for the coming year which can be read here. It is hard to argue with his logic and if forced to make predictions, I would probably come up with something similar. It largely reflects the internal discussions we’ve been having over the last few weeks and so is a good representation of our views right now. Like John Maynard Keynes, however, if the facts change so will our minds so don’t take it as a road map that can be followed blindly. As John himself points out, “economic forecasting has as much credibility as tarot card-reading”. That might be more of an insult to tarot card readers than economists. Economists can’t even agree on what happened in the past much less predict the future. The debate over what happened during the Great Depression is as lively today as it was during the Roosevelt administration.
So if we can’t predict the future – and neither can anyone else – how do we invest amidst all this uncertainty? Luckily, investing doesn’t require an ability to predict the future. It does, however, require a certain confidence that the past is at least a reasonable facsimile of the future. One has to believe that humans will continue to strive to improve their well being and that they will be reasonably successful. One has to believe that despite their best efforts, the politicians won’t impede that progress completely. One has to believe that the vast majority of investors will do the wrong thing at the wrong time and produce opportunity for those willing to buck the consensus. One has to believe that the price one pays for an asset matters a lot and is a determinant of the future return. And finally, one has to understand that managing investments will involve misjudgments and mistakes. It isn’t how often you are right but how much you lose when you are wrong and how much you make when you are right that determines success.
So, with all that as preamble, here’s how I see the investing landscape right now:
This is how I see things today and our portfolios are positioned accordingly. I’ll spend this year as I’ve spent the last 20, observing markets and economies. If – when – things change so will the portfolios. We’ll get some things wrong and adjust. We’ll get some things right too though and hopefully that will be enough to produce another year of good returns.
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The economic data released since my last update has been fairly positive. Last week’s reports reinforced the perception that the US economy is slowly improving. Whether it continues into the new year is something no one can predict but so far there are few signs of impending recession. I hesitate to say that we are out of the danger zone though; the US economy still faces significant challenges. Monetary policy is mysterious at best (see this post by John Chapman) and fiscal policy looks locked in until after the election. I see little reason to expect any major improvements in policy for at least 18 months. Still, the economy so far seems to be avoiding any fallout from the European mess and the data continues to surprise to the upside.
The ISM indexes were both released last week and pointed to continued expansion. The manufacturing version came in at 53.9 and the details were pretty positive. New orders rose nearly a point to 57.6 signaling an acceleration in order growth. Even export orders improved. Employment was up 3.5 points to 55.1. The non manufacturing index wasn’t as positive but still showed modest expansion at 52.6. New orders were up 0.2 to 53.2. Backlog contracted at an accelerating rate which probably explains the employment component coming in at 49.4. Factory orders were also up in November by 1.8%, led by strong aircraft orders. Ex-transportation, orders rose a more modest 0.3%. Capital goods orders ex-aircraft were down 1.2% which doesn’t bode well for investment. One positive was a 1.3% surge in unfilled orders.
Construction spending for November was up 1.2% with residential outlays rising 2%. Non residential was unchanged. The year over year rate of change for construction has now turned positive, up 0.5%. Construction will probably add to GDP this year but the gain will probably be modest.
The Redbook and Goldman retail reports both showed acceleration, with same store sales now up roughly 5% year over year. Chain stores generally reported better sales but with large markdowns at some stores. Auto sales were basically flat in December compared to November at 13.6 million units. The official retail sales report should show a slight improvement over November.
The big reports for the week were on employment and all were positive. ADP reported a large gain in private sector jobs, up 325,000. Weekly jobless claims fell to 372k in a continuation of the trend lower. As I’ve said in the past though, I don’t trust the seasonal adjustments for claims this time of year so I’ll need to see continued improvement in the new year. The official jobs report Friday also showed a robust gain of 200,000 jobs with the private sector gaining 212k while government lost 12k. The underlying stats also were generally positive. Goods producing jobs were up 48k; construction added 17k, manufacturing jumped 23k. Service jobs were up 164k but some of that was just temporary hiring for the holidays. We saw something similar last year and it was reversed in January so hold the champagne. Average hourly earnings were up 0.2% and the workweek extended to 34.4 hours. The unemployment rate was 8.5% based on the household survey but that includes a 50k drop in the workforce. Overall, it was a positive report but still not enough to say all clear. Let’s hope it is the start of a new trend for 2012.
Markets were generally better last week with the S&P 500 up 1.6%. That’s better price appreciation than we had all of last year and the market is acting pretty good right now. Unfortunately, everyone has noticed and bears in the weekly AAII poll have dropped to less than 20%. In the past that hasn’t been good news for the near term outlook and I would not chase this rally. Emerging markets and Europe were also higher last week but are still lagging the US. Gold rose on the week but is now trapped just below the 200 day moving average. Gold continues to look bearish against a dollar index that is trending nicely higher.
We have not made any changes to our portfolios recently and are maintaining a healthy cash reserve. The outlook from Europe and Asia remains too murky to get overly aggressive in my opinion. Bond yields in Europe were higher across the board last week with the ECB apparently buying Italian bonds late in the week. While we seem to have dodged any fallout from Europe so far, the economic data comes with a lag and I expect to see some effect in the reports over the next few months. Sentiment could turn on a dime and I would prefer to have too much cash than too little.
For information on Alhambra Investment Partners' money management services and global portfolio approach to capital preservation, Joe Calhoun can be reached at: jyc3@alhambrapartners.com
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