2012 Investment Themes Reviewed

2012 Themes: The More Things Change.

 

Since we’ve now closed the chapter on 2012, we’d like to review our “10 economic themes for 2012” from last January to see how well our ideas performed.

We’ve graded ourselves using these symbols: ? Right,  X Wrong, ? Not Exactly.

1. ? Steady as she goes: We think it unlikely the Fed will raise rates in 2012, largely due to the presidential election… We were largely right here. The Fed held rates steady ahead of the presidential election. We will admit to being surprised at the robust extension of QE as we did not expect the Fed to make as controversial a decision only a few months ahead of an election.
2. X Risk Off: We believe risk assets (stock, real-estate, long-dated and high-yield bonds) will have a difficult 2012. Stocks have benefited from a sharp rebound after the credit crisis and are now back to the higher end of the historical range. Bonds meanwhile, are trading at yields that are lower than any seen in two generations. During the course of 2012, we would expect both to correct towards the mean. This should provide some interesting buying opportunities, especially for dollar-based investors. We were flat out wrong here. Both stocks and bonds performed well in 2012. Stocks did well as vast amounts of monetary support helped lift demand from depressed levels. Bond prices were supported by the Fed’s steady purchases over the course of the year, and investors’ rediscovery of the appeals of fixed income.
3. ? Break-Up or Make-Up, Brussels is good for both: 2012 should be the denouement for the European sovereign debt crisis… We believe a Greek default is extremely likely this year. Even if there is a pre-negotiated haircut with some lenders, the market will treat it with the seriousness that the first default by a “developed” economy in a generation should. In either case, Greek bondholders should be prepared for losses on the order of 60% of par value.  We are giving ourselves a half point here.  Greece did not default, even though private Greek bondholders will have to settle for 50 cents on the dollar.  However, by strong-arming creditors to accept the most draconian restructuring in recent history, Greece has managed to avoid the imprimatur of default. Greece continues to struggle and there is a another restructuring possible in 2013.
4. ? Euro Trash: We expect the Euro to bear much of the burden of the European sovereign crisis, and the currency to weaken significantly against the dollar. When we discussed a Euro break-up last year, it seemed like an outlier scenario. We have been amazed at the speed with which events have moved and a potential Euro-exit for one or more peripheral economies is now being openly discussed. We were wrong here.  The Euro did indeed weaken by 10% over the summer, but by the end of the year it had made up the loss.
5. ? Blue States/Red States: This is a two part theme. The presidential election cycle should be the major story in the US in 2012. In our view though, the more critical issue is the associated discussion about the US and individual state debt burdens. The charmed baby-boomer generation will have to decide how much of a cut in benefits is acceptable to ensure the burden of their entitlement programs in coming years does not doom the economic future of their children and grandchildren… Surprisingly the presidential election did not settle these issues. The topic remains hotly debated in Washington and the prime driver of US bond markets. Rating agencies continue to scrutinize every move in Congress with an eye towards the country’s AAA rating.
6. ? Chinese Math: At the 18th Communist party congress, we expect power to be transferred to a new generation of Chinese political leaders. We have no doubt that the enormous state apparatus will be fully utilized to ensure economic stability during the transfer. However, we believe these efforts will ultimately be for naught. The structural shift required in China as it moves from an investment driven economy to a consumption driven one will make for a tumultuous year in Chinese markets. The stock market has been depressed for almost five years, and we expect Chinese real-estate is beginning to make the first moves in an unavoidable decline towards more reasonable levels. We give ourselves a qualified right on this one. There are signs that the Chinese economy is faltering, and real-estate prices have begun to fall.  But none of these has occurred to the extent we had anticipated.
7. X Revolutionary Times: …We expect to see more political turmoil in Europe and the Middle East in 2012. This coupled with major elections and power-transfers in the US and China make for a very uncertain 2012 politically speaking. In our view, this will make for very jittery markets throughout the year. No doubt, 2012 was full of political upheaval and this was reflected in the markets with many sectors seeing large swings over the course of the year.
8. ? Oil Slicks: The events in the middle-east will of course have an impact on energy prices. We expect political tensions to keep oil prices artificially inflated in 2012, but longer-term we think $100 oil is unsustainable as alternative energy sources approach cost-parity with conventional sources… Oil had a tough time rising despite extreme uncertainty in the Middle-East, it is still around $100. We give ourselves a draw on this one.
9. ? Smart Homes: The past decade has seen the widespread adoption of computing and telecommunications technology touch virtually every aspect of human activity. We expect the markets to be enamored with a couple of very high-profile IPOs expected in 2012/2013 (Facebook and Twitter). We believe some of the higher profile IPOs of 2011 will perform poorly (GroupOn for instance)… We were largely right here, with some of the more questionable business models (like GroupOn) falling out of favor with investors. The most significant Internet IPO of the past five years (Facebook), was overpriced at issue and dropped significantly in the first few months.
10. ? Housing: Still a buyer’s market: We expect the overall US housing market to remain stagnant in 2012 with pockets of strength, particularly in major urban areas (NYC, DC, San Francisco) and some suburban and rural areas that did not overbuild in the run-up to the credit crisis…  We were largely right here, the US housing market continues to languish at low levels of activity with prices not far from the lows in most markets.