Nolte Notes for January 2nd 2012Paul J. Nolte - Monday, January 2nd, 2012

Happy New Year and good riddance to 2011! Not that last year was lacking excitement, from market volatility to debt ceiling showdowns to global debt defaults. The ancient Chinese curse or proverb (depending upon source) “may you live in interesting times” can be validated to some extent by the market gyrations of the past decade. When looking at the absolute daily moves of the markets compared to the beginning market value the past decade has registered 5 of the top 17 most volatile years. Only the 1929 crash and decade to follow (11 consecutive years!) provided more excitement. Given the markets finished the year essentially unchanged: going nowhere fast also comes to mind. Given the month/quarter/year change, the bigger question is whether the markets and economic conditions change as the calendar flips. The Magic 8-ball answer is doubtful. Global economies are struggling under the heavy debt burdens that now have to be paid or re-configured. Given too the lack of political will to make difficult and enforceable decisions (both here and abroad), the most likely “decision” will be to postpone the day of reckoning by any means necessary. That means more liquidity (money) will be pumped into the global economy that will have to find a home. As a result, asset prices should rise over the course of the years, however their path will be anything but straight.

As is the annual ritual for many fields, the turn of the New Year brings out the predictions the coming year in… dominate the papers. However what is usually missing is a look back at those predictions from last year to see how things actually stacked up. The shape of the markets (good first, lousy second half) and the finishing ranges of +/-5% were on the mark, the interest rate forecast and portions of the markets that would do well were wide of the mark. The operating thesis for each year is a culmination of trends that tend to remain in place for many months. So emerging markets and small cap stocks had been doing rather well over the prior six-month period and remained so into 2011 until the rather abrupt change at the end of July as investors began fretting about the loss of AAA status on US debt and heightened concerns over global sovereign debt. From that point, the defensive portions of the markets, dominated by high quality US stocks in consumer, healthcare and utilities groups provided some shelter from the storm during the last part of 2011. Since little has changed over the past few months, expect that those themes will carry well into the early portion of 2012 before a change occurs, likely mid-year, toward more aggressive and maybe international stocks once again.

Expectations for interest rates centered around the need for rates to move higher (and prices lower) as the flood of stimulus would certainly spell doom for the 30-year bull market in bonds. That scenario may yet play out, but investors continued to flock to Treasury securities during the year as global debt concerns rose a credit downgrade in August notwithstanding. A quick survey of forecasts for 2012 indicate many are calling for higher interest rates (how low can they really go?!), however the global debt crush will remain a wet blanket on economic growth, preventing rates from rising significantly over the course of the year. So “the call” would be for relatively low rates to continue through the year, with treasury bonds to be in a 30 basis point range around 2% in 2011.

The shape of the markets for 2012 is likely to be the mirror image of 2011, with weakness in the first half of the year and stronger toward the end. The kicking of the debt can down the road over the past year is likely to continue this year, however the road is rapidly coming to a dead end. As options to solve the problems diminish, the financial markets are apt to remain volatile with more negative reactions than positive during the first half of the year. Once we get deep into the election season, nearing the conventions, the markets may begin their bottoming process that would allow for a rally into the end of the year, carrying into 2013. The wild card is and has been debt problems around the world. Implications for the financial markets are that “solutions” to the debt issues will be at the expense of global growth, potentially hurting corporate earnings. As discussed above, the beneficiaries of a slow-growth environment will be the larger multi-national companies that are in defensive industries: consumer staples, healthcare and utilities. Valuations for these companies are getting expensive, so their leadership is not likely to be maintained throughout the year, so a shift is likely later in 2012.

The volatility of 2011 is not likely to abate in early 2012 and a good long-term buying opportunity could present itself toward mid-year as debt problems frustrate investors. Defensive sectors should do well early in the year with a shift toward international holdings later in the year. Bond investors shouldn’t see rates significantly higher during the year, but rates, like stocks, will be volatile as debt issues dominate the markets again in 2012.

The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.



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