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Advice for Investors in 2012: Balance Allocations, Strategize, and Hang On Tight!

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Those continually beating the negative drum will have a few wins in 2012, but those who have good portfolio balance will be rewarded for patience -- especially here in the U.S.

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Like a bad cruise through a hurricane, last year was certainly no vacation that you would care to repeat. However, just like the cruise, at the end of the year we found ourselves generally back in port, according to the U.S. indices at least, and slightly worse for the wear from the punishment felt in Europe and parts of Asia.

Reviewing what I wrote to end 2010, I'll attempt to not completely repeat myself, but not only was the market basically flat, but so were all of the political and economic situations we faced. We hear a lot about the do-nothing Congress (and White House and EU), and for 2011 it was absolutely spot on – plenty of noise, emotion, smoke, mirrors and posturing, but with very little action. We first outlined the problems in Europe way back in May of 2010, and the year ending note discussed the American political discord as well as the slow (and generally ignored) improvement in the economy. All of that was accompanied by the general malaise and fear of any risk from the public or investment professionals. A year later and not much has changed.

The politicians on both side of the pond – while continuing to be completely spineless, leaderless and selfish – have proven at least one thing which is a positive for the markets and probably explains some of the recent calmer seas: They will take action if they absolutely have to in order to avoid complete disaster, and not a moment sooner. This appears to be the direction we are finally heading, especially in Europe. It's very similar to a teenager writing a term paper. Unfortunately these issues are slightly more important. The problems we face financially on both sides of the Atlantic can no longer be partially solved (the vernacular being "kick the can down the road") without causing far more damage. We have some time, but it is running very short.

Another potential positive is that everyone has become too irrationally negative; it's almost the antithesis of the late 1990s. I don't like to be a contrarian just for the sake of being a contrarian, and the old saw about a market's ability to remain irrational longer than you remain liquid is a truism, but any positive comments currently put forth are shouted down immediately with a million statistics behind the vitriol. Exactly the same as happened to folks who uttered a remotely negative phrase in 1999 or 2006. The wall of worry is being rebuilt daily, with reinforced concrete! I'm not calling for a dramatic turn right now because we are knee-deep in political mudslinging, which is a real wildcard in the short term, but at least in bond-land, I haven't seen this many people piled up against the gunwales on one side of the boat since Nasdaq at the end of 1999!

It is one of the main reasons it's wise to not strictly rely on any single set of data or reports out there. Instead, try to look at everything in context. As I listen to the daily negative spin from the talking heads of the investment media, I am reminded of a study out sometime in the past few years discussing how very smart people may not make as many mistakes as people who are not as smart, but when they are wrong it can be spectacular. The core reason behind the conclusion was that very smart people can always find some kernel to support their thesis once they buy in, and it may be more difficult to argue against the position as they build their wall and become even further convinced of their own brilliance.

It showed up this past year in the form of several wildly successful fund managers who survived and even thrived in 2008 -- having seen the financial tsunami coming and possessing enough guts to position for maximum advantage at that point -- but absolutely came apart at the seams in flat but volatile 2011. It seems to be something we have all intrinsically known for a long time – and as Mark Twain stated over 100 years ago, "There are lies, damn lies, and statistics." I think it's good to be reminded of that when the media is driven by whatever is the popular message of the moment. Also another reason the famous mainstream magazine cover indicator is somewhat effective – following the herd is rarely profitable in the longer term. Or as one of my degenerate gambling pals likes to say – "fade the public."

Something else I've also noticed over the past several years: There are now a large percentage of folks in the investment business who have never seen a real bull market as a pro -- the complete opposite as to how the 1990s to early 2000s appeared. While this probably breeds those who are a little more contemplative than a monkey with a buy-button (to quote a favorite 1990s blast), but what this also does is lead to wildly misallocated portfolios in the opposite direction. For you football fans out there, you know that prevent defense only prevents wins. You play to win (cue the Herm Edwards drop) – you do not play to simply "not lose."

A symptom of all this angst and fear is that the term "Black Swan" has gone from signifying a rare statistical outlier (that most had not even heard or thought of) to being viewed as a rational, regular expectation. The reason they are called "hundred-year floods" is not because they happen every three or four years. That's not to say I don't think there is downside risk with the continuing EU disaster as well as our own political folly, but to constantly be looking for the next catastrophe like the dot-com bubble or Lehman dying as the canary in the housing-bubble coal mine is counter-productive.

A good rule of thumb – and the basis for fantastic annual prediction lists from the likes of Byron Wien and Doug Kass ("possible improbables") – is that you invest for what is probable and hedge for or speculate on what is possible. Don't ignore the risks, but it's an enhancement to the long term core, not the entire strategy. A "perfect hedge" provides a zero return.

Finally on the positive front: Jobless claims continue their downward move. (It's the direction, not the absolute rate that moves the sentiment needle.) The U.S. economy is still growing despite almost everyone's call to the contrary after the EU disaster and concurrent debt ceiling debate meltdown. And consumer sentiment improved again, driving Christmas sales up dramatically – we are a consumer-driven economy in America, after all. On top of all that, I learned last week on a research call that we ended the year with almost $9 trillion (with a "T") in cash – with a third of that in money market funds. Lots of dry powder waiting for the emotional spark….

Although, the Christmas shopping item was a bit of an odd story and why I continue to state that what the politicians say in the media truly matters to the economy almost as much as their actions (or lack thereof). When asked this year in the pre-Christmas economic surveys, the majority of people said they were going to spend more this year, but still stated they thought the overall economy is worse with little sign of improvement. Perception is reality in the short term.

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No positions in stocks mentioned.
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