As went 11 so starts 12 …

A sudden bold and unexpected question doth many times surprise a person and lay them open.  ~Francis Bacon

The passage of time doesn't necessarily equate with actual change in society.

The issues that loomed over the financial markets in 2011 still persist at the start of 2012 and still weigh us down like a virus ignoring its antibiotic.

I don’t have to persuade you that our world is changing.  Globalization of commerce has changed forever how we do business.  The media continues to have a huge impact on our sensory perceptions of the world around.  In my opinion, this media impact is mostly negative.  It seems to me that the media has never met a negative story that it didn’t like.  Our culture is changing our value, also not for the better, again, in my opinion.  And technology is changing our lives literally a half-year at a time, if the current speed of technological change continues unabated.  For the most part, I view technological change for the betterment of our lives – unless it begins to take the place of the things in life that it is intended to serve.  That said, historians cannot understand any age until it passed.  I wish I could truthfully tell you that the “The 2008 Great Recession” has passed, but it has not.  Here in America, the financial crisis that birthed the Great Recession has now sauntered into the “Long Slump.”

In 2011, the seven billionth person was born into a world that is richer, healthier, and, arguably, safer than at any time in history.  And yet uprisings from California (Occupy Wall Street Protesters) to Cairo (Mubarak overthrown) to Libya (ridding themselves of the tyrant Gaddafi) to Wall Street itself (the starting point of the Occupy Wall Street (OWS) protests) became commonplace news items week after week, becoming slime oozing out from our T.V. sets. The OWS protests started a national dialog about the concentration of world wealth.  However, in my perspective, their anger was misdirected.  The job creators of America are not the problem; the selfish politicians looking out for their own best interests are indeed the problem. 

In that regard, nothing has changed for hundreds of years. (See my first sentence above).

My take on 2011 is that it was an “angry year.” Anger caused revolution in Egypt, Libya, Syria and other Middle Eastern countries.  And yet, by historical measures, there’s not that much about which to be angry. Throughout history, most anger of the people has been restrained to sovereign borders.  In 2011, anger went viral.

And so we begin to look at what 2012 might offer.

Let’s go back to the basics: The purpose of production is consumption. The immediate follow-up to that is Consumption should not be financed.

To counteract fear, investors turned to dividend-yielding stocks.  Indeed, 2012 might be best remembered as the “Year of the Dividend.”  I expect to see more of the “risk off” mindset and more of the “show me the money” mindset as investors want a hedge on the investments by requiring some cash in return (the dividend) for the risk they are taking.

Nobel Laureate Joseph Stieglitz has noted that the Great Depression was the last time unemployment exceeded 8% four years after the onset of a recession.  We are nearing that four-year time frame.  If you are looking for comfort, you have no farther to look than Germany and its wayward children: those would be pretty much the rest of Europe, certainly the rest of the southern Europe nations.  Angela Merkel is, indeed, “the lady with the check book” to quote Evan Cooper from Investment News.

As for employment, about 58% of us can say we are fully employed; in 2002 – in a recession­ – that fully-employed number was 65%.  So, you can see that we are indeed becoming less affluent.

Recently, a client walked into my office and said: “Charlie, I long for the good ole days: ten years ago, I had my heroes: Johnny Cash, Bob, Hope and Steve Jobs.  Now we have no jobs, no cash, and no hope.”  After I finished laughing, I had to tell my friend that I simply didn’t agree with that negative a viewpoint of the future.

So can the U.S.A. still provide growth for the world economy in 2012? As you likely know, we are no longer the leader in world growth: China has provided 40% of global growth since 2008!  Their growth rate is expected to drop from 9.3% (!) to 8% (still!!) this year.

Do we have it bad here? How would you like to be less than thirty years of age and unemployed in Egypt (30% unemployment rate)?  Or Greece (40% unemployment rate)? Here in the U.S. that same youth rate is a “mere” 18%. Germany, the richest and most powerful nation in Europe has insisted its less-affluent neighbors swallow the medicine it prescribes: an austerity pill for all nations with debt that is consuming their economy.  As might be expected, the nations of Southern Europe flinch at said prescription and are, to this point, refusing to take their medicine because they don’t want to sacrifice the quality of their debt-financed lifestyle.  This is the same deficit lifestyle that caused the riots in the street of Paris and Athens in 2011.  Some technocrats and elected officials are slow to learn; their subjects are even slower to learn. 

Incredibly, the total European economy is greater than the U.S. economy.  So it is impossible for us in America to decouple from an impending growth rate in Europe of 1% on the top side to a contraction of 2.5% on the downside.  2012 prediction: as goes Europe’s woes so goes the U.S.’s prosperity.

The dissolution of the Euro is not our greatest threat (U.S. debt is #1), but it is the threat most likely to occur.

I’ll re-state my summary projection for 2012 is this: as goes the European Crisis, so goes the world economy, and thus the financial markets.  The number one question I am asked is this: what is going to happen to the European Countries struggling to meet their debit obligations?  There are four basic outcomes possible:

1)       Growth their way out of debt. This is the best possible as well as least likely scenario.

2)       Require that bondholders accept a loss. This means that for every dollar invested in sovereign debt, a debt holder would have to agree to
          accept less money– much less – when the cash is returned to them at bond “maturity.”

3)       Default on Euro-denominated debt.  In this case, the offending country would exit from participation in the Euro and return to its former
          national currency (i.e. Greek drachma or Italian lira).

4)       Promote domestic austerity.  Belt tightening and budget cuts will need to be extensive, but this is the only credible way out of the gluttony in
          which Europe finds itself.

So what do you think? Do the industrious, serious and orderly Germans want to bailout the Greeks, Italians, and Spaniards, who they, the Germans, view as unmotivated, lazy and fun loving?  I think Europe will drag down the world economy in the first half of 2012 and China will pull it back up in the latter half of 2012.  Will Germany be able to strike a balance between the needs of Europe and willingness of German taxpayers to pay for the financial excesses of the smaller nations?

In the long run, the euro experiment will fail.

So, how does that affect our investment strategies in 2012?  At CB3, we ask ourselves: if the stock market were closing tomorrow for a year, would we be satisfied with our current holdings?  While I don’t believe that is anywhere near a likely scenario, it does suggest that we are proceeding with more caution in our investment choices for 2012 than we did at this point in 2011.  The market is there to serve you and not to instruct you.  Our investment results state how well we are learning to react and adjust to market conditions.  Another way to state this is a stock doesn’t know you own it and that you may have feelings about it.  A stock doesn’t know or care what you paid for it. Once we accept this, it makes it easier to remain (wisely) emotionally unengaged with the investment process.

Unlike 2011, we will be pursuing dividends in every portfolio we trade, even our speculation Spec Opp trading program.  Since 1926, 40% of the S&P’s return has been dividends.  Stock valuations as we enter 2012 are attractive at 12 times forward earnings.  In 2002 – ten years ago – stocks were trading at 25 times forward earnings.  We saw how that turned out. Non-financial balance sheets are in very shape cash-wise.  As a percentage of total assets, cash is very high by historical measures.  Companies are hoarding this cash because of the aforementioned U.S. deficit uncertainly, European leadership frustrations, and the looming corporate cash-draining effects of Obamacare in 2014.  Companies are crouching in fear of more adverse government, policies well as liquidity shock fallout from a possible collapse of the Euro experiment.  Instead companies are using their cash to buy back stock and increase dividends.  With Steve Jobs gone (who never would allow a dividend to paid on Apple stock), even Apple is considering using some of its $85bn in cash to pay a dividend for the first time in its company history.  As previously stated, I believe 2012 will be the year of the dividend and a more conservative posture for risk taking across the asset allocation universe.

Have a terrific New Year; may 2012 be your best ever.  We at CB3 look forward to the challenges, surprises, and yes, blessings of 2012!

Towards Prosperity,

              Please mark your schedule for the Winter 2012 Financial Fireside Chat at the Batavia Library on Wednesday, January 18^th, 2012 at 7:00 pm.