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Five Macro Themes and Three Investment Ideas for 2012

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A recent investment outlook roundtable was the catalyst for some big picture thoughts, some current themes, and several new investment ideas for the new year.

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A recent investment outlook roundtable was the catalyst for some big picture thoughts, five current themes, and several new investment ideas. Steady as she goes is the meme because, for all the angst in financial markets, changes to the key underpinnings of what is occurring (or not) in the world economy have been limited.

We remain in a global deleveraging process. This is most acute in the developed economies but may spread to the emerging economies via Europe's debt crisis.

Coupled with the deleveraging process is a shortfall in global aggregate demand. Western consumers seek to pay down debts built up in the early years of the 21st century while emerging consumers grow their purchasing power. The demand rebalancing from the US to the rest remains far from complete.

Political dithering in Europe has allowed a liquidity problem in most cases to morph into a solvency question for many banks and some sovereigns. If anyone needs a bullish start to 2012, it is European banks as they seek to raise capital – early day returns (Unicredit) do not bode well with negative implications for the magnitude of Europe's credit crunch.

Central banks in the US, Europe and Asia have employed varying degrees of monetary policy to offset these interrelated problems. What monetary policy there is has been nullified to a large extent by a wrong-headed political embrace of austerity, especially in Europe but also to a lesser degree in the US. Expect a very deep recession in Europe where even Germany feels the pain. The Fed's efforts at QE show the way: banks hoard capital, liquidity stagnates, economies weaken, central bankers become politicized, earnings fall. The ECB is now learning this lesson.

The global framework remains much as it has been for several years: developed economies face sub par growth/recession and deflation risks while emerging economies enjoy better growth with rising inflation, now morphing into stagflation (defined as inflation rates higher than growth rates). Growth drivers in the developed or emerging economies for 2012-2013 are very hard to identify given the deep recession one can expect in Europe, the fiscal drag baked into the US cake and China's political-economic transition. Bottom line – downside risks seem to far outweigh upside opportunities.

Five Themes

Five themes emerge from this worldview: bifurcation; corporates lead; US is the place to be; the search for yield; and the global tide turns. Lets explore each in turn.

Bifurcation: spreads around the globe, across assets and among peoples. 2011 was the year of Occupy Wall Street, but it was the 1% who made the money, a clear example of bifurcation that will influence the globe's socio-political landscape for years to come. Bifurcation between labor and capital stimulates social tension; between political parties ensures gridlock and dependence upon unelected central bankers; between financial assets creates volatility and shrinks liquidity.

Corporates lead: Among the three main actors (individuals, governments and corporates) corporates are in the best shape, certainly among the developed economies and only marginally less so in emerging economies where sovereigns are in good shape. The consumer is strapped in the West and worried about inflation in the East. Governments have taken on the debt of the banks and in many cases are much worse off than 2008. US corporates will have close to $2 trillion in cash over 2012... stock buybacks are likely to be the C suite strategy of the year!



US (financial assets) outperform the rest: is a longstanding theme. US corporates are best placed to find growth opportunities, the US economy is in better shape than the rest with a manufacturing renaissance and energy boom, the Fed is on hold thru 2013, the USD is in recovery mode.

The search for yield: will define the investment landscape for some time to come. The number of pension, endowment and other funds that have 7-8% return targets is very large – the opportunity set to generate such returns with low risk is very small – ergo, find-those-spots-and-get-there-first is likely to be a pretty decent investment strategy.

The global tide turns: We are witnessing the reversal of the global financial tide as well as the end of the global supply chain. Europe's bank woes ensure the tide is turning and will continue to turn as capital is brought home. Rising wages in emerging countries, high fuel costs, more extreme weather in more parts of the world and the desire to be closer to one's customers suggests the next stage for the global supply chain will be a roll back to regionalization.

Three Investment Ideas

I have two new ideas and one repeat.

The two new ideas are: First, go long US small caps, and second, go long EM high dividend paying stocks. I do not short but for those who do, going short US large caps and US high dividend stocks would be natural corollaries to these ideas.

US large caps were huge beneficiaries of Europe's woes in 2011 as money fled Europe while US investors likewise looked for safety and companies able to access global growth. Hence US large caps sharply outperformed small caps. I expect this to reverse in 2012 as the European contagion finally hits the US. It can't be stressed enough: the US was a huge winner in 2011, with massive equity outperformance, a great year in UST and a decent year in terms of the USD. However, in 2012, European contagion will hit US large cap earnings as the USD rises and EU economies collapse (the 2011 surprise of euro at 1.10 by year-end wasn't wrong, just early). US 2012 consensus earnings say up 5-8%; expect down close to 10%. Small caps are more exposed to the US economy and provide shelter from the European storm.

US high dividend paying stocks were the safe haven du jour in 2011; ETFs for this theme took in the most money. While 2012 outlooks differ on many points, owning US high dividend paying stocks is a consensus view – that in itself suggests being somewhere else. That somewhere else is in emerging market high dividend-paying ETFs. The latter yield more, trade at a sharp discount to their US peers and are far from being overowned given EM stocks in general were down 20% in 2011.

The repeat is to hold onto one's yield plays including long dated USTs – return potential remains even after last year's near 30% appreciation. Few folks recommend it, even now, and if one believes that the EU debt crisis is far from resolved then UST can continue to get a safe haven bid, remain supported by a ST – LT rate spread that is close to historical highs, not lows and come with a guaranteed buyer in place (Operation Twist). USD denominated EM debt positions should be kept intact as should infrastructure investments.

A steady as she goes macro environment suggests a steady state portfolio.


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No positions in stocks mentioned.
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