Why Stocks Could End 2012 Up Over 40%
Making the case for why 2012 could be like 2003 and 2009, and why a huge move could be coming.
OK, before we begin, I want you to keep an open mind. First, as followers of my writings are aware, I believe firmly that conditions matter more than predictions. My colleagues and I focus on the direction of inflation expectations as the core central thesis for what drives the asset allocation decision (risk-on = stocks, risk-off = bonds). My firm's ATAC (Accelerated Time And Capital) models are built around this core concept and attempts to quantitatively determine what the crowd thinks about inflation/deflation going forward. The intermarket analysis I do is what led me to call for a deflation pulse exactly one year ago when Marc Faber of the Gloom Boom and Doom Report published a writing of mine making the case.
The deflationary conditions markets were sensing was the genesis of the Summer Crash call first made in June. The exact opposite analysis led me to the conclusion that we were headed for a Fall Melt-Up as I called it when I started writing about it in late-September (see From Summer Crash to Fall Melt-Up?). I was even interviewed at the Wall Street Journal live a few days after the October 3 low making the case. For fun, without the benefit of hindsight, that interview can be seen here. Keep in mind I had a really bad haircut before that segment!
My point in stating all this is not to pat myself on the back. Far from it – I simply want to show that my historical analysis and interpretation of market conditions makes me not a perma-bull or perma-bear, but perma-interpreter. My objective if anything is to show that I am listening to markets and making my observations here on Minyanville (particularly through my weekly Lead-Lag Reports and the Buzz & Banter postings I send out daily). Marc Faber just yesterday published a piece of mine in which I specifically argue for 2012 to be the year of reflation similar to 2003 and 2009, and that the "bond bubble" everyone focuses on could just be about to burst.
If I'm right, the biggest risk to investors may perversely be not taking the risk (after the fact with hindsight, of course). I co-wrote a piece with Peter Atwater of Financial Insyghts addressing the problems with risk -- a piece I highly recommend reading to provide a different perspective of how one thinks about it from a portfolio perspective (see Thoughts on the Risks of Being a Bull or a Bear). What if we make new all-time highs as I stated alongside my partner Ed Dempsey as we co-hosted Bloomberg Rewind with Matt Miller last week? If 2012 does end up being the year of reflation like 2003 and 2009, that shouldn't be too hard to believe.
But where am I coming up with the idea that stocks could advance more than 40% this year? Let's consider the performance of the S&P 500 (SPY) in 2003 and 2009. Sure, both years were big years for stocks, but remember that during the first three months of both years, stocks first went lower before bottoming in March (around the same time coincidentally for both years). Off of the March 11 low in 2003, the S&P 500 advanced 40%. Off of the March 2009 low, the S&P 500 advanced over 67%. Again, both years were defined by reflationary environments.
What if March 2003/2009 is happening right now, just earlier in 2012? Given the conditions favoring inflation expectations returning to markets, and a scenario whereby money flows out of bonds and into stocks, why is it so impossible to think that an extreme move higher could not happen? Notice I'm not making a prediction here – I am making the case that based on historical periods of reflationary environments, a big move can happen. The conditions seem to suggest this is not a far-fetched possibility. Also remember that 2011 was a pre-election year for markets. Historically, pre-election years are very strong for stocks and risk-assets. Europe clearly short-circuited that, but what if the cycle was delayed and the move we could have experienced in 2011 was simply delayed to 2012?
Again – the conditions matter. One way of seeing the potential for reflation to occur is to look at the price ratio of the iShares Treasury 7-10 Year Treasury Bond ETF (IEF) relative to the iShares Treasury Bond 20+ Year ETF (TLT). As a reminder, a rising price ratio means the numerator/IEF is outperforming (up more/down less) the denominator/TLT.
I used a similar chart in Marc Faber's writing. An uptrend in the ratio occurs when the yield curve is steepening (inflation expectations returning = bullish). A downtrend in the ratio occurs when the yield curve is flattening (inflation expectations falling = bearish). I have annotated the chart to show the relevant trends. Notice the substantial potential for long bonds to underperform shorter-duration bonds. And keep in mind, this could occur with equities already at elevated levels.
Remember – black swans aren't always negative. Markets have a funny way of surprising both bulls and bears. I wouldn't mind taking a 40% move...how about you?
This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
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