Financial Outlook for 2012

We are rapidly coming to the point where we can no longer stuff the dirty clothes and toys under the bed. There is no more room. We are going to be forced to actually deal with the mess.

~ John Mauldin, 2012: A Year of Choices

Just a few weeks into 2012, markets have been mostly positive – until Friday’s European credit rating downgrades and JP Morgan’s disappointing earnings results derailed the enthusiasm. The warm holiday glow of optimism seems to be fading and 2012 is already starting to feel a lot like 2011, with all of the queasiness that went with it. Today we take a look at some of the themes I think will dominate the financial news this year as well as some 2012 insights from folks who are a lot smarter than I am.

2012 Overview: Volatility & Whiplash

I chose bifurcation as the main theme for 2011. I think that theme will continue (along with biflation) this year. We are likely to see more pressure on consumers due to rising food and energy prices coupled with a lacklustre economy and job market. I’m going with volatility as my main theme for 2012. I think investors will continue to experience chronic whiplash this year as markets adjust to headlines on an everything’s fine vs. the financial system is going to hell in a handbasket basis.

The secular bear market that began around 2000 will continue until the deleveraging process ends and the market clears the glut of debt built up from the last secular bull market (1983 – 1999). Will that happen in 2012? I don’t know. But I’m pretty sure we’ll have another financial crisis at some point in the not-too-distant future and I’m playing it safe with our investments for now as a result.

Top Financial Themes for 2012

1. Sovereign Debt: Eurozone debt concerns dominate the headlines right now, and they do pose a potential threat to the financial markets. But let’s not forget that Japan, the U.S., and the U.K. are sporting some pretty hefty debt-to-GDP ratios as well. It’s only a matter of time before all of that comes home to roost.
2. China: Some say China’s real estate market is ready to implode thanks to excessive lending. Others say the Chinese authorities will successfully engineer a soft landing. Will China be able to support the global financial system by buying up a bunch of debt? I wish I knew the answers to these questions. Unfortunately, all I do know is that a serious glitch in the Chinese economy has the potential to further destabilize the global financial system. If markets think China is going to be OK, however, that could prove to be a calming, if not stimulative elixir for markets. As a result, I’ll be watching the Shanghai Composite Index more closely this year.
3. Global Growth Slowing: Most economies worldwide seem ready for a slowdown, with some facing imminent recessions and others, potentially depression-like conditions. Although many corporations have reported excellent profit growth since the 2008 crisis abated, a slowdown in global growth will temper or reverse those tailwinds.
4. Geopolitical & Civil Unrest: North Korea has a new, untested leader. Iran is kicking up dust over their nuclear program and the Strait of Hormuz. The Occupy movement has died down a little, but could easily resurge along with other forms of civil unrest if another financial crisis erupts. These are some of the issues that could affect markets and money in 2012.
5. U.S. Election: Raise your hand if you’re already tired of the 2012 U.S. election coverage. It would be wonderful to have some white knight take the Presidency, clean up the infantile partisan political structure, and kick out the powerful lobbyists that buy and own government policy. How many of you think that’s going to happen? It seems like we’re still stuck with a major leadership vacuum just at the time we desperately need some adult guidance. Absent our fabled white knight, I don’t see a way for the political machinery to help smooth the obligatory deleveraging process.
6. Fed Policy: Will the Fed implement QE3? If they do, the markets will likely rally wildly, but this type of policy will only prolong the inevitable debt reckoning.
7. Pension Problems: I mentioned this as a dark horse for 2011. Many pension funds are drastically underfunded thanks to record-low interest rates and lackluster equity returns. I’m not sure this will affect markets directly in 2012, but it’s not a problem that’s going away and it’s something for all of us to keep in mind as we try to plan for our own retirement. I hope to write more on this topic in 2012.

2012 Insights

I’ll just quickly share a few of the 2012 commentaries that caught my eye so far. All are worth your time:

• 2012: A Year of Choices ~ John Mauldin
• 2012 Investment Themes ~ Gary Shilling (via John Mauldin)
• Hope for 2012 ~ Danielle Park
• 15 Surprises for 2012 ~ Doug Kass
• The Right Kind of Hope ~ John Hussman

Doug Kass is the lone bull in this group. Both Mr. Mauldin and Ms. Park quoted John Hussman in their articles and I loved the quote both times, so I thought I should share it with you here in case you missed it:

Happy New Year. We enter 2012 with a great deal of hope, but our hopes are not for more bailouts, or money printing, or any of the myriad policies that investors seem to hope will save bad investments and sustain elevated valuations. Instead, our hope is that in 2012, the market will finally “clear,” in the sense that bad debt around the world will be recognized as bad and restructured; that overleveraged financials will be taken into receivership instead of forcing austerity on every corner of the global economy in order to make them flush again; that rates of return will rise enough to compensate and encourage saving – and high enough to encourage borrowers and other users of capital to allocate the funds productively. Of course, in order to restructure bad debt, someone has to accept a loss. In order for rates of return to rise, valuations must decline. In short, our hope is for events that will unchain the global economy from an irresponsible past and open the gates toward a prosperous future. Maybe that is too hopeful, but we are not entirely convinced that bailouts and “big bazookas” will be as easily procured in the year ahead as a confused public has allowed in recent years. ~ John Hussman

These are my thoughts on financial markets at the beginning of 2012. Care to share yours?