Archive for Strategy Lab

10 Questions (and Answers) for 2013

I’m doing a pre-emptive Q&A this week covering a  macro view of 2013.  I generally don’t believe in forecasting a full year out because I think it’s impossible, but that doesn’t mean we can’t provide some general guide posts for the year given what we currently know.  I usually update these views on a quarterly basis (more frequently through the research with specific market views) so this is probably more like a Q1 outlook with some vague 2013 commentary.  And unfortunately, because the fiscal cliff remains unresolved a lot of this is just pure speculation….But I hope this helps frame the big picture for you.

1) What Will Happen With US Fiscal Policy?

With the fiscal cliff still entirely unresolved this one remains a bit hard to decipher.  A worst case scenario of $500B+ in cuts to the 2013 budget would drive us down from 2012’s $1.1T budget to something in the $600B range.  With a private sector that is still de-leveraging and unable to run with the baton since the damage of the credit crisis has been inflicted this would obviously have very damaging effects on the economy.  Recession is a near certainty in a worst case scenario.

The more likely scenario is moderate cuts and another year of economic muddle through as the budget deficit remains large enough to offset a healing private sector.

Downside risk: The obvious risk is Washington.  A poor outcome on the fiscal cliff means an already fragile economy will be driven into recession.  I am substantially more concerned about recession in 2013 than I was in 2012 as the risk of austerity is higher.

2)  What Will Happen with US Monetary Policy?

This one looks like a no-brainer.  The Fed has been pretty clear that they’ll remain accommodative through 2015.  The recent change in communication and timing made it clear that they’ll be on hold until the unemployment rate drops below 6.5%.  Even in a best case scenario the unemployment rate likely won’t hit 6.5% until the middle of 2014 so it looks like we’re in accommodation mode for the duration of 2014.

Downside risk:  Ben Bernanke is likely to step down in 2014.  Could he become less accommodative later in the year in order to create flexibility for a smoother transition?  Or could policy take an unexpected turn due to the uncertainty that is likely to develop in the market surrounding this event?

3)  Is the US Economy Headed into a Recession?

I’ve been pretty vocal over the last 18 months since the ECRI came out with their recession call.  I said the US economy would not enter a new recession in late 2011 or 2012.  The thinking was relatively simple.  Because the US economy remained in a balance sheet recession you had to throw all the past historical data out.  None of the models applied to what we are going through.  What did apply was understanding how the US economy was de-leveraging and that meant the private sector was too weak to sustain growth on its own.  That meant we needed the public sector to pick up the slack.  You’ve probably seen this chart (or some version of it) a million times here:

What happened to the US economy was an unprecedented collapse in private investment.  Normally, the private sector alone can bring us out of a recession.  But this was no ordinary recession.  Private investment cratered over 20%.  This was beyond unusual.  It meant the private sector was flat on its back.   And more importantly it meant that the huge public deficit was supporting incomes, driving revenues, and generating an economic “flow” where there wasn’t one.

It’s kind of like the office building called the US economy was burning down and the indoor sprinkler system stopped working.  A balance sheet recession isn’t merely a contained one office fire.  It has the potential to wreck the building.  So, what was needed was an outside flow.  That arrived in the form of government spending.  It not only put the fire out, but saved the building from collapsing.

Anyhow, it’s hard to tell whether there will be a recession in 2013 due to the fiscal cliff circus, but if we get a relatively sane response then the budget deficit should remain large enough to support the private recovery in 2013.  On the other hand, in a negative cliff outcome the US economy almost certainly suffers the European fate of austerity in a BSR and enters recession.  I am going to make the insane call of assuming politicians will do the sane thing in the next few weeks and avoid a major budget catastrophe in 2013.  Therefore, I still don’t see the recession in the USA this year, but the odds are substantially higher than they were in 2012.

Downside risk:  It’s all about the cliff.

4)  Is Global Growth Going to Slow?

Global growth appears to be stabilizing.  The USA has maintained a muddle through environment, Europe has been mired in recession and Asia has stumbled a bit in late 2012.  But that third leg of the stool (Asia) appears to be turning a corner.  This has been apparent in global PMI data where the GDP weighted PMI is turning positive for the first time since early 2012.  I think global GDP should stabilize further in 2012 largely on the back of a stabilizing Chinese economy.

Downside risk:  The Chinese government fails to act in front of a still very fragile economic environment.

5)  Is the Euro Crisis Over?

The Euro crisis never ended.  As I’ve explained before, this remains a currency crisis and not a banking crisis.  The problem in Europe is that the Euro remains unworkable.  The single currency system has locked its users into a fixed exchange rate regime without a fiscal rebalancing mechanisms.  In other words, unlike the USA (which is almost perfectly analogous to Europe’s union) there is no central treasury to rebalance any imbalances.  Most people aren’t aware of the fact that the USA is actually a huge fiscal transfer union.  The wealthy states pay more into a system that redistributes funds to weaker states.  This helps eliminate the solvency concerns and trade imbalances that naturally develop in any fixed exchange rate system.

Europe has no such arrangement so the only rebalancing mechanism is through painful austerity and time.   The result is depression in many regions. Unfortunately, there hasn’t been any permanent fix to this problem.  Instead, the ECB has implemented a series of measures that help reduce the solvency risk at the national level which brings private bond buyers back to the market, but this is far from a permanent fix to the underlying economic problems in the region.  The Euro crisis remains one of the primary risks to the global economy.

Downside risk:  The big risk is civil unrest which leads to potential defections and defaults.  The citizens of Europe are unlikely to put up with depressionary economics forever.

6)  Where is US Employment Headed?

Last year I said we were making “baby steps” in the right direction on the employment front.  Understanding the balance sheet recession has been all about understanding the growth of private credit.  As the lifeblood of our monetary system private credit tends to correlate with the unemployment rate and rate of hiring.  The one positive trend we’ve seen on the employment front is the beginning of gains in private credit accumulation.  As you can see in the chart below, private credit (inverted) is beginning to turn the corner.  The process is slow and remains incredibly fragile, but it’s moving in the right direction.  I don’t think it’s unreasonable to assume that the unemployment rate will drop below 7% this year for the first time since the crisis flared up.

Downside risk:  Again, it’s all about the cliff and austerity.  Austerity would hurt private balance sheets and likely cause a freeze in credit accumulation and hiring.

7)  Will High Inflation Finally Arrive in 2013?

In 2012 I expected disinflation leading to a level where the Fed would feel comfortable intervening with QE3 around the middle of the year.  I’ve been lucky predicting inflation in recent years.  Looking forward, we’re likely to see many competing forces on the inflation front in 2013.  Oil prices are still very high, credit trends are improving, government spending remains high and yet hourly earnings are still near rock bottom.  Ultimately, I think the two primary drivers will be credit trends and hourly earnings.  Continuing weak demand for credit and virtually zero earnings power on the labor front will continue to suppress inflation.  Contrary to popular opinion, I am not a deflationist and haven’t been for many years.  So, I see positive inflation, but low inflation in 2013.

Downside risk: Or should I say “upside risk”?  It is definitely oil prices.  A repeat of something like 2008 cannot be ruled out.  Particularly with the volatility in the Middle East.

8)  Will hyperinflation finally come in 2013?

I’ve had a lot of fun over the years at the expense of the hyperinflationists.  But that was mostly in trying to create a teachable moment about the way our monetary system works (see here for more). As I’ve long predicted, hyperinflation is not a serious risk in the USA because hyperinflation is far more than a monetary phenomenon and none of the conditions that precede hyperinflationsts are present in the USA.  I would place the risk of hyperinflation in the USA in 2013 at approximately 0%.  I’d go negative if I could.

Downside risk:  None.  I honestly don’t think there is any risk of hyperinflation in 2013.

9)  Should You Buy a House in 2013?

5 years ago I was a big housing bear.  I wouldn’t say that I’ve done a 180 here, but I’ve definitely become much more constructive on housing in recent years (see here and here).  The keys in the housing market has been sizable declines in inventory, vast improvements in affordability, improving price to rent ratios and substantial price declines across the nation.  I still think we’re in the midst of a post-bubble “workout”.  Like most bubbles, it’s highly unusual for prices to bounce back quickly.  Instead, we’re likely to see a flat-lining in prices.

Despite the many calls for recovery this year, I still don’t see a big recovery in housing.  That said, I also don’t see great downside in prices.  We’ve already had a massive decline in real house prices so I think we’re most likely to see moderate gains at best in 2013.  If you’re looking to buy a home in 2013 and you’re looking to live in that house then I think the downside risk are fairly limited.

Downside risk:  I hate to be a broken record, but the risk here is in the fiscal cliff and the potential that incomes from government spending decline substantially which puts downside pressure on the economy.

10)  What Will Happen to Corporate Profits in 2013?

Last year I predicted that corporate profits were likely to come under pressure for the first time since 2009.  As Q3 operating earnings come in at just 1% I think that has become a reality.  There are a lot of moving parts here, but the likelihood of slow corporate profit growth is likely to continue into 2013.  Revenues are slowing into the low single digits, corporate profit margins are high and profits have soared on the back of the large budget deficit.  I think the risk to all of this is to the downside.  I am much more concerned about a profits recession in 2013 than an economic recession.

Downside risk:  Again, understanding the Kalecki equation shows us that corporate profits have benefited enormously from the large budget deficit.  If the fiscal cliff results in a substantial decline in the budget in 2013 we should expect a profits recession.

Credit Suisse: 6 Reasons to be Bullish

In the face of increasing uncertainty and economic weakness we can always count on one of the big banks to find the bullish case (via Business Insider):

“We are positive on equities as:

1) economic lead indicators, although beginning to soften, are consistent with reasonable GDP growth forecasts;

2) dovish central banks and synchronized QE are the end game;

3) rising global excess liquidity is consistent with a c10% re-rating;

4) valuations relative to bonds are still attractive;

5) equities remain the hedge if, as we expect, long-term inflation expectations rise;

6) positioning is still cautious.”


David Kostin, chief U.S. equity strategist at Goldman Sachs has bucked the bullish trend in the first few months of the year after having been bullish for a long time.  Kostin vocally called for S&P 1,250 despite the persistent rally in the first 4 month of the year (see here).  Kostin now says the S&P is likely to end the year down slightly at 1250 (4.2% lower than today).  He broke his reasoning down based on three big trends:

1.  Stagnating US economy.

2.  Multiples are likely to stagnate

3.  Earnings growth is slowing.

Kostin says the S&P is likely to earn $100 this year and that margins are likely to contract.  I think his positioning is totally rational given my own outlook for earnings and the very low upside potential and substantial downside risks heading into the latter portion of the year (see here for more on that).

Kostin also outlined Goldman’s hedge fund monitor and the stocks most aggressively accumulated and most owned by hedge funds.  Goldman’s hedge fund VIP basket recently added the following names:

Barrick Gold (ABX)

Berkshire (BRK)

Calpine (CPN)

Devon (DVN)


Capital One (COF)

Salesforce (CRM)

Ebay (EBAY)


Ford (F)

Hertz (HTZ)

Rock Tenn (RKT)

Equinix (EQX)

Hess (HES)

Illumina (ILMN)

WellPoint (WLP)

The names most DROPPED by hedge funds are:



McDonalds (MCD)

Amazon (AMZN)

WalMart (WMT)

Exxon (XOM)

The 5 names most owned by hedge funds are:

Apple (AAPL)

Express Scripts (ESRX)

Google (GOOG)

Microsoft (MSFT)

Qualcomm (QCOM)

You can see the full Kostin interview at CNBC.


By Walter Kurtz, Sober Look

Hedge funds have been known to move stock prices, sometimes dramatically raising volatility of specific shares. Here are two latest trends on hedge funds’ equity holdings that may have some impact on equity volatility going forward.

1. Investment allocation in small-, mid-, and large-cap stocks for an average fund is about a third for each of these categories. So one would think that by taking the full hedge fund universe, it would be equally weighted across the three capitalization groups. But that is far from reality. Small hedge funds like small-cap stocks and large ones prefer large-cap stocks. It means that as the large funds become even bigger, the overall percentage of large cap stocks within the hedge fund universe should rise (simply because large hedge funds control a bigger portion of the total hedge fund assets). That has indeed been the case, with small caps representing only 17% of the overall hedge fund equity AUM.

Source: GS

2. Hedge funds run highly concentrated portfolios. The latest numbers from Goldman indicate that top 10 positions make up some 64% of hedge fund equity portfolios. That compares to 34% for large-cap mutual funds. Such concentrations indicate that hedge fund overall performance is driven by just a few stocks.

Source: GS


Combining 1 and 2 above tells us that certain large-cap stocks could experience dramatic moves, as hedge funds change positions in these names. Large concentrations and significant holdings could result in some outsize volatility.


Here we go again.  It’s all about Europe.  And now we’re all in wait and see mode on Greece and whether they’ll default and defect and possibly trigger the Lehman 2.0 scenario that so many have been worried about for years now.  In many ways this market has a 2008 feel to it.  I wouldn’t say it’s quite the same because the global economy had been on a 5 year credit binge just waiting for a negative catalyst that came in the form of house price declines.  Today’s environment is a little different.  Back then we were Mike Tyson walking around sticking our chin out and taunting the idea of recession and a knock out punch.  Today, we’re Mike Tyson fumbling around looking for his mouthpiece after the Buster Douglas knockout blow.   We’re barely on one knee.   So kick us over if you want – we won’t fall very far.  In the case of some European nations we’re not even talking about being on one knee.  Spain and Greece for instance, are flat on their backs, barely breathing.  They didn’t get hit by Buster Douglas.  They were hit by a Mack truck that kicked it in reverse and came back to run them over just for good measure. So my decoupling call for Europe is still on.  I just don’t see how they pull out of this tailspin without some sort of unified action….The USA is recovering, but still weak.

I still don’t think the USA is on the verge of a renewed recession, but I know the risks are rising.  My worst fear is that all this chatter of a “fiscal cliff” is paralyzing corporate America to the point where business investment is going to come to a halt from its current crawl.  The one really positive sign in recent quarters has been the continued recovery in business investment paired with the government budget deficit.  This is all part of the balance sheet recession healing process.  But we’re at serious risk of this process coming to a stop.  And recent rhetoric out of Congress regarding the debt ceiling isn’t helping matters.  So I admit that the risks of recession are certainly rising, but the data isn’t there yet to convince me that my long-standing “no recession” call needs to be changed.

As for the markets – it’s a mess out there.  Messier than I thought they’d be.  And that’s coming from a guy who was building a short position all the way up to SP 1420.   But I was a buyer in small bits on Thursday.  My indicators aren’t raging bullish, but I do think we’re beginning to see some fear levels and market action that is generally consistent with a market that is a bit overdone on the downside.  We’re seeing lots of extremes in different markets with the Euro tanking, Treasuries spiking and equities getting bludgeoned in a matter of weeks.  The bears are betting on a worst case scenario and if Europe stays true to their actions of the last few years the bears will once again find themselves on the wrong side of the trade resulting in a rip your face off style move against them.  I wouldn’t get wildly bullish here because the worst case scenario is certainly not off the table.  But from a risk management perspective I certainly feel better about owning equities 8% cheaper than they were just a few weeks ago….


Jeff Gundlach just wrapped up another conference call and he made some good (and bad) insights.  Here are the key takeaways:

  • He says Greece is likely to leave the Euro as the situation continues to spiral out of control.
  • Spanish equities are a decent risk-on asset if you have to choose something in Europe.  But he’s not sure if you’ll make money….
  • He seems to be joining the Kyle Bass team with regards to Japan’s debt situation….
  • Germany is near a recession.
  • The long natural gas, short Apple trade has performed well so far….
  • QE3 is more likely after recent economic data.
  • Keep an eye on the week of June 18th where we have a big Fed meeting, another European leader’s conference and implementation of the Volcker Rule.
  • The Fed won’t raise rates unless CPI gets very high.  He says those who think we’re reliving the 70’s are wrong.  “It’s not gonna happen”.
  • He says housing in the USA has not bottomed even though it’s becoming fashionable to call the bottom now.  Housing will “bumble along”.
  • There’s not a great deal of downside in 10 year yields….
  • Gold is a reasonable thing to own here….


By Robert Balan, Sr. Market Strategist, Diapason Commodities

There has been a lot of debate about the end of the “Commodity Supercycle” in recent days. The subject came up along market speculations that a hard landing will take place in China, and that the “miracle” is “over. The premise here is that if the infrastructure development of China is over, then surely the so-called “Commodity Supercycle” is over.

Could this meme be correct? We disagree with those notions on five counts: (1) We do NOT believe that China is in for a hard landing (we expect higher growth in Q2 2012), and (2) even if China’s growth ratchets down from “boiling” to “simmering” that does not necessarily mean an end to the upward trend in commodity prices as other emerging countries and even OECD economies would soon take up the “slack” from Chinese demand moderation;

(3) a China paradigm shift from investment to consumption does not necessarily derail the commodity gravy train — it just rearranges the order and the number of the train cars; (4) the Fed’s reaction function almost guarantees that rates will stay low too long again, and will likely re-ignite inflationary pressures in a 1970 context; and (5) the “commodity supercycle” being discussed is not really a “Supercycle”, but only a “boom” in a longer, larger, higher-amplitude period of economic activity (the “Long Wave” or “Kondratief (K) Wave”) which could top out in sometime in 2022-2026.

Read the full report attached below:






By Charles Rotblut, CFA, AAII

“Sell in May and go away” is strategy that some investors and traders are likely contemplating right now. The adage is based on the historically weaker performance of stocks during the May through October time period. Adherents shift from stocks to cash at the beginning of May and then invest back into stocks at the start of November.

Historical performance shows there are best and worst six-month periods for stocks. Jeff Hirsch at the Stock Trader’s Almanac calculates that the Dow Jones industrial average has an average return of just 0.3% during the worst six-month period (May through October) since 1950. Conversely, during the best six months (November through April), the Dow has an average gain of 7.5%. Sam Stovall at S&P Capital IQ says the S&P 500 has risen by a mere 1.2% during the average worst six-month period, while rising 6.9% during the average best six-month period. (Sam’s numbers go back to 1945.)

Certainly, last year made selling at the end of the April seem like a prudent decision. From the end of April 2011 to the end of October 2011, the Dow lost 6.7%. Using the October 4, 2011, intraday low as the endpoint, the drop worsened to 19.1%.

As we reach the end of April this year, the problems in Europe that caused last summer’s weakness (e.g., Greece’s sovereign debt) have not gone away. Plus, Spanish bond yields have recently risen, French president Nicolas Sarkozy is in a closely contested run-off, the Dutch coalition government has collapsed and Britain’s economy is contracting. In Asia, China’s economy has shown signs of slowing, and Standard & Poor’s just lowered its outlook for India. In the U.S., many politicians remain more interested in bickering and getting quoted than agreeing on long-term solutions.

Even with these legitimate concerns, things could still go right or, at least, conditions could hold up well enough to support stock prices. Europe could simply muddle along, as opposed to worsen. China’s economy may slow less than forecast. Gasoline prices in the U.S. may have peaked (fingers crossed). The U.S. economy may maintain its uncomfortably slow, but ongoing, recovery. (The Federal Reserve boosted its 2012 GDP growth projections yesterday.) Plus, low valuations could limit any downside to stocks. (The S&P 500 is trading with a forward-looking price-earnings ratio of 12.9.)

You also need to consider the downside of selling stocks. Yields on six-month Treasuries are 0.14% and says money market accounts are yielding 0.46%. Your broker will charge you commissions for selling stocks, and if you sell shares in a taxable account, the IRS will bill you too. Then there is the question of when you will get back into stocks. Were you buying during last August’s or October’s lows, or were you selling? What about at the start of last November?

My cracked crystal ball cannot predict how much or how little downward volatility we will see over the next six months. Given how strong the first quarter’s rally was, a summer pause in the markets would not be surprising, but a pause is far milder than a correction. Then again, if global (or domestic) economic conditions surprise to the upside, summer flowers may not be the only thing blossoming. What I can say is that you will be taking a risk either way, but over the long term, stocks reward those who take prudent risks.

A middle-ground strategy is to see if your portfolio allocation is still close to your targets at the start of May and the end of October. If your allocations are more than five percentage points off target, rebalance. For example, if your strategy calls for a 60% allocation to stocks and stocks currently account for 66% of your portfolio, reduce your stock allocations back to 60% and shift the proceeds into the asset class that is currently underweight (e.g., bonds). This allows you take advantage of the best and worst six-month periods by selling high and buying low, while still adhering to your long-term investment plan. (If you are unsure as to how you should be allocating your portfolio, our Asset Allocation Models may help.)

Charles Rotblut, CFA is a Vice President with the American Association of Individual Investors and editor of the AAII Journal.


By Walter Kurtz, Sober Look

How does one make money on a portfolio of alternative energy companies? Here are a few possible ways such an investment could work:

1. You hit a motherload by having a portfolio company invent some technology that would successfully compete with traditional energy sources on price and availability. It’s a nice dream to have, but so far significant advances toward this goal have been elusive. This would not be a good investment strategy/thesis because it can not be relied upon to generate consistent returns (unless of course you focus on socially responsible investments irrespective of the return expectations).

2. You could have your portfolio companies lobby politicians to provide attractive tax breaks for alternative energy, benefiting your portfolio.

The Motley Fool: Most politicians love renewable energy, because it gives them a good excuse to increase the taxes on non-renewable energy, and it lets them buy votes and campaign donations by giving taxpayers’ money to the renewable energy industry.

Naturally, whenever a government is giving away money, you get a big queue of people who want a piece of the action, and some renewable energy companies have been much more successful in getting subsidies than in producing commercially profitable applications.

Consequently, there have been several subsidy-related scandals, such as the one that surrounds the politically connected solar cell manufacturer Solyndra, which obtained hundreds of millions of dollars in US federal government loans and loan guarantees shortly before filing for bankruptcy. Solyndra is now being investigated by the Federal Bureau of Investigation!

Well, maybe relying on tax incentives to generate returns isn’t such a great idea.

3. You work with your portfolio companies to convince politicians to punish traditional energy firms for using traditional energy sources (by increasing their costs) in order to encourage alternative energy uses.

The Motley Fool: In 2008, [the UK] parliament passed the Climate Change Act to encourage the adoption of renewable energy by deliberately increasing the cost of non-renewable energy. I also see it as providing a strong incentive to invest overseas, as it will damage British industry, since our energy costs are going to increase at a much greater rate than those of our foreign competitors.

The government’s own figures indicate that this act will cost industry some £400 billion and increase the average British household’s energy costs by around £760 a year. That’s a big burden to bear, and it looks as if green policies will continue to put pressure upon domestic and commercial budgets.

Hmmm, that doesn’t seem too sustainable or profitable for that matter.

4. Your final alternative, and the one that is most likely to succeed, is to bet on peak oil. When crude goes above $150, these alternatives should do well.

The Motley Fool: One thing that’s guaranteed to improve renewable energy’s economics is an oil crisis, preferably one which sends prices soaring to well above $150 a barrel for a long period of time.

But wait, if you are betting on peak oil, why not just buy traditional energy companies that would do well in a significant oil price appreciation? You don’t have to bet on smaller firms or rely on tax breaks. With traditional energy firms one may do well even without an oil crisis. Better yet, why not just go long oil futures. This way you have no business risk at all – the peak oil effect would go straight into income.

These four options just don’t sound appealing, making the alternative energy asset class fairly unattractive as an investment. And the markets happen to agree. Over the past couple of years the overall energy sector globally has been flat to up slightly. The alternative energy space however is down some 65% over the same period.

MSCI World Energy Sector Index vs. MSCI Global Alternative Energy. Index (Bloomberg; click to enlarge)


By Walter Kurtz, Sober Look

At times when faced with stressed financial conditions, it is helpful to look through history for periods that bear similarities to the current environment. Obviously no two periods are ever the same, but the period of mid 40s to early 50s in some ways resembles markets of today.

US 10-year treasury yield


Throughout WW-II and for some time after, the Fed conducted what could amount to QE by capping treasury yields. It allowed the US Treasury to finance the war effort at historically low rates by continually purchasing treasury securities. As an example, below is an excerpt from the FOMC minutes of February 29, 1944.

In the mid 40s the stock market had a fairly sharp correction after a strong rally, as the war-based industries had to shift focus toward the private sector (the familiar shift from government stimulus toward reliance on the private sector). From that point on the market did not materially appreciate until the early 50s.



As expected it was the high dividend stocks that outperformed during that period. The chart below from Barclays Capital shows the relative performance of high to low dividend stocks.

Source: Barclays Capital


The outperformance lasted for some five years through the stress period. In 1951 the Treasury-Fed Accord eliminated the Fed’s obligation to the US Treasury to purchase its securities at a fixed rate (which was forcing the Fed to grow balance sheet indefinitely.) This event began the normalization of the Fed’s monetary policy and ended the outperformance of high dividend stocks.

The chart below compares the Vanguard High Dividend ETF (VYM) with the overall market (SPY). Over the past year, VYM has outperformed SPY by close to 7%.

VYM vs. SPY (Bloomberg)


Based on the similarities between the post WW-II period and now, this high dividend stock outperformance should continue until the Fed ends the period of easy monetary policy. And from all the indications we have, the Fed’s extraordinary accommodation should be in place for some time to come.


They’re 4% late to the party here, but Goldman Sachs is officially jumping on the bearish bonds bandwagon….probably earlier than most though (via Zero Hedge):

“Since the end of last August, we have argued that 10-yr US Treasury yields would not be able to sustain levels much below 2% in this cycle. Yields have traded in a tight range around an average 2% since September, including so far into 2012. We are now of the view that a break to the upside, to 2.25-2.50%, is likely and recommend going tactically short. Using Mar-12 futures contracts, which closed on Friday at 130-08, we would aim for a target of 126-00 and stops on a close above 132-00.

…At this stage of the cycle, growth expectations are in the driver’s seat: The value of intermediate maturity government bonds can be related to expectations of future policy rates, activity growth and inflation, and a ‘risk factor’ highly correlated across the main countries.

Bond valuations are already stretched relative to consensus growth expectations: Around the turn of the year, the outlook on economic activity was buffeted by cross-currents reflecting the adverse credit conditions in the Euro area on the one hand, and the upward revisions to US GDP growth on the other.

The FOMC statement could provide a near-term catalyst: According to a client survey by our US trading desk, around half of those polled expect the Fed announcement to ease financial conditions further, with only 12% expecting a tightening.”

Source: Goldman Sachs



Talk about sticking to your guns here – John Hussman still believes the likelihood of recession is very high.  It’s a call that he’s been making for a number of quarters now and was clearly influenced by the ECRI’s rather confident recession calls.    I wonder what Lakshman Achuthan is thinking about the recent economic data….

As I’ve long been saying, I still think the large budget deficit makes the likelihood of a technical double dip low in 2012, but risks are increasingly high that that could change in 2013 as the budget deficit peels off (I’ve been playing this by ear as quarterly deficit estimates are released).  The main point is, we remain in a balance sheet recession which appears to be showing slow healing signs and as long as the government supports the de-leveraging consumer with high deficits the economy is unlikely to experience any sort of substantial decline.  I still think my 2013/2014 end date is not far off.

Of course, Hussman is working from a totally different macro framework than I am and I’d be a fool to claim that there’s no chance that he ends up right and that my macro framework falls apart in the coming years given the numerous inputs that could change the outcome.  Dr. Hussman elaborates on his current outlook:

“The interpretation best supported by the data is that recession risk remains very high based on the leading evidence and the typical outcomes that have resulted, but that the rate of deterioration has eased significantly, and it is simply unclear whether this is a temporary pause or a reversal. Rather than overstating the case one way or another, we remain strongly concerned about recession risk, but recognize the recent stabilization and the potential for a low-level continuation of that. On the indicator front, the economic data over the coming week could be informative (especially the introduction of the Conference Board’s revised LEI, the Chicago Fed National Activity Index, and unemployment claims), but if the new data also muddles around near the flat-line, it will essentially reinforce the overall view that the global economy is close to slipping into recession, but is at least temporarily stabilizing.

Importantly, the recession risk we’re observing is evidenced in a wide variety of indicators, various sets which we’ve reviewed in a number of recent weekly comments (see Dwelling In Uncertainty ). For example, the chart below shows three widely-followed leading indicators: the OECD (Organization for Economic Cooperation and Development) Leading Economic Indicator for the total world, the OECD LEI for the U.S., and the ECRI (Economic Cycle Research Institute) Weekly Leading Index growth rate. All are presented in standardized form – zero mean, unit variance. The blue shaded areas are actual U.S. recessions. The yellow brackets depict what we call a “discriminator” – a variable that strongly discriminates between two groups of data, in this case recessions versus expansions. This particular variable shows the points in history when all three of those leading indices were below -0.5 (based on standardized values), and the average of the three was less than -1.0. Recessions have always produced this condition, and this condition has only been associated with recessions. Notably, this discriminator is active at present.

Despite the record of this and other indicators, we have to suspend the inclination to view recession as a certainty. It’s still possible that this instance is different, and that the modest stabilization we’ve seen in recent economic data will be sustained enough to avoid a recessionary outcome. But in my view, the downside risk is high, and it entirely strains the evidence to say that we can discard recession concerns on the basis of the more comfortable data points we’ve seen in recent weeks.”

As always, Dr. Hussman’s full letter is quite good….



By Surly Trader

There are certain times when the markets just seem to disconnect.  Right now that disconnect is between the US dollar, US interest rates and US equities.  Since the end of November we have seen a growing disconnect – primarily between equities and other asset classes (see figure 1).

Is it strictly related to money flowing into US assets regardless of what they are, or is the market setting itself up for a large correction.  Seems to me that one side of the equation is going to get hurt by a reversion to normalcy.  At this point, who are you going to place your bet on – bond buyers or equity buyers/vol sellers?

Some ideas to bet on a reversion:

  • Short equities, short 20+ year treasuries
  • Long volatility, short 20+ year treasuries

Sizing the trade is the tricky part…


It’s that time of year when investors are prepping for the new year and economists and advisors are offering their full year perspectives.  I tend to think that full year macro and micro outlooks can be misleading since I don’t believe in the ability to accurately forecast the economy 12 months in advance, but these sort of reports can certainly help one in generating a macro perspective and strategic approach.  The following is a broad array of macro outlooks and strategic approaches to the markets in 2012.  Enjoy.

Macro Outlooks and Predictions

Predictions are hard, especially about the future….

Top equity strategist outlooks for 2012 –  Business Insider

Difficult 2012 for fixed income?   –  Morgan Stanley

How to trade emerging markets in 2012 – CitiGroup

2012 global strategy – Bank of America

2012 Market outlook – Ed Yardeni, Yardeni Research

10 surprises for 2012 – UBS

Recession in 2012?  Flip a coin – SF Fed

2012 Forex shocker – Nomura Research

Will 2012 Be Europe’s Minksy Moment?  – PIMCO

2012 outlook – Jim Rogers

5 key questions for 2012 –  Goldman Sachs

2012 – the year of diminished expectations – Mark Zandi, Moodys

2012 Global outlook – Morgan Stanley

2012 – The Year of the reckoning – Peter Schiff

The 6 biggest questions of 2012 answered – Bob Janjuah, Nomura

Richard Bernstein’s favorite picks for 2012

Bob Doll – 10 predictions for 2012 – BlackRock

Will the shorter business cycle lead to recession in 2012?  –  Deutsche Bank

Continued volatility, but no recession in 2012 – Jeff Saut, Raymond James

5 Consumer challenges heading into 2012 – Gluskin Sheff

2012 outlook on China – The Telegraph

Forecasting Italy’s Borrowing needs in 2012 – Sober Look

The three recession risks – Credit Suisse

Europe to double dip in 2012? – Capital Economics

Sluggish growth to continue –  CEO & CFO surveys

The “Doomsday view of 2012″ – Binghamton University

Eurozone debt redemptions will force Europe to act in 2012 –  Credit Agricole

Depression will lead to collapse of the Euro – Felix Zulauf

Recession is still coming – Lakshman Achuthan, ECRI

No way to avoid recession in 2012 –  Hoisington

2012 will mirror 2009 –  Societe Generale

The global economy to slow in 2012 – ScotiaBank

5 important global trends to watch in 2012 – Nomura Securities

Moderate economic expansion to continue – FedEx Corp

The risk of recession has come down – Goldman Sachs

Still no recession in the foreseeable future, but a balance sheet recession – Cullen Roche

Growing signs of a disinflationary 2012?  –  Cullen Roche

The 2012 earnings outlook –

5 macro trends for 2012  – Council on Foreign Relations

Strategy, Risks & Top Trades for 2012

Bridgewater – buy treasuries and gold, sell stocks…

7 Calls for 2012 – Nomura Securities

15 surprises for 2012  – Doug Kass

A bullish outlook for gold in 2012 – Deutsche Bank

House prices to drop 30% in 2012?  –  RBC

8 Risks to equity markets in 2012 – Morgan Stanley

10 outrageous predictions for 2012 – Saxo Bank

4 risks in 2012 – Bank of America

Oil to rally again in 2012  – CitiGroup

10 market risks in 2012 – Nomura

2012 is shaping up to be a good year for equities – David Kotok

Stay in the equity game – PNC

The Dow:Gold ratio will hit 1:1 – Bob Janjuah, Nomura

10 for 2012 - Byron Wien, Blackstone

Gold is the ultimate bubble and could be on the verge of massive bear market – George Soros

2012 investing outlook – Kiplinger

How to invest in 2012 – JP Morgan

Oil prices just can’t fall much –  Barclays

Europe’s banks are insolvent – Michael Platt

Credit strategy 2012 – CitiGroup

2 bullish drivers for 2012 – Credit Suisse

Morgan Stanley 2012 commodities outlook – Morgan Stanley

6 reasons to remain bullish –  Jeff Saut, Raymond James

The 2012 commodities outlook – Diapason Commodities

Is QE3 on the way?  –  Cullen Roche

Still long gold and copper – Goldman Sachs

A sober look at natural gas – Sober Look

5 Investment themes for 2012 – Richard Bernstein

The consensus gold outlooks – Zero Hedge

7 investment ideas for 2012 – David Rosenberg, Gluskin Sheff

5 Risks heading into 2012 – David Rosenberg, Gluskin Sheff

Key Euro Crisis milestones ahead – DJ FX Trader

5 reasons to overweight the UK relative to EMU - Goldman Sachs

Top trades for 2012 - Goldman Sachs


By Walter Kurtz,

The US equity market is poised for a near-term rally. It is a difficult statement to make, given all the headwinds, but the signs are there.

Let’s start by looking at US based factors that should impact the S&P500. 

1. The US economic data coming in has been quite decent. The initial jobless claims are at the lows.  We all know the issue with the US unemployment figures, but the trend is unmistakable.

Initial Jobless Claims (Bloomberg)

2. US equity valuations look attractive on a historical basis.  The next chart shows the S&P500 P/E ratios, both trailing and projected plotted over time.  The last time we were at these levels was in early 2009.

PE ratios (Bloomberg)

3. Interest rates, and in particular the mortgage rates are at historical lows.  The 30-year fixed conforming mortgage rate is now below 4%.  This will generate some refinancing for those who are able, adding some disposable cash to the system.


4. Commodity prices, particularly food and energy have come off sharply.  Corn, wheat, cotton are near recent lows. This should be a positive for both the US consumers and many corporations.  Having access to abundant cheap domestic natural gas should be helpful as well.  The chart below shows the CRB commodity index.

CRB Commodity Index (Bloomberg)

5. A technical concern weighing on the markets has been the issue of option expiration. This Friday (12/16) is the largest option expiration of the year with about $950 billion worth of S&P500 options (on futures and ETFs). Investors are uneasy about large short gamma positions distorting the market. This overhang will be out of the way next week.

Source: Goldman Sachs

Now let’s consider the developments in Europe that have been holding down US equity valuations. 

6. Europe has gotten serious about their fiscal integration plan. France and Germany are driving the process and the eurozone is on board – at least for now.

7. We had two critical auctions – one for Italian bonds and one for Spanish bonds. The yields are high, but these nations were able to sell all the debt they planned and as far as we know the debt was sold to private investors. That gives the eurozone hope that these countries can in fact roll their debt without the EFSF, the ECB, or the IMF – at least in the near-term.

8. The upcoming sovereign downgrades by the S&P have been clearly telegraphed to the markets.  And now with the auctions out of the way, the ratings may actually come in better than expected given the results.

9. Central banks have shown a willingness to provide unprecedented support to financial institutions.

Clearly tremendous risks remain and we may yet revisit the “dark days” of September. But in the near term the overall picture looks positive and the S&P500 has a “green light” to rally.

* Walter Kurtz is a credit specialist at U.S. based hedge fund.