4th January 2012: Investment Themes For in 2012: Summary Of Risks And Opportunities For In the Year Ahead

Quote of the Day:

The level of concern that we have about what is going on in Europe is absolutely huge. We receive evidence all over the markets these days that the pricing for the potential of a Eurozone break-up is distinctly non-zero – contrary to everything that is said by policy-makers and by central bankers.

Michael Platt – CEO

Macro Overview

Positive Themes for 2012

• There are many things to be positive about in 2012 for investors.
  • The corrections in asset prices have obviously left securities at more tempting levels than than they were before.
  • European leaders have not found a solution yet, but they have made huge strides towards achieving, at least an avenue towards a solution.
  • Central bankers are not only ready to throw the kitchen sink at the problem, they are acting in concert and with cohesion. While the effectiveness of these measures is questionable, the symbolism is there for all to see; central bankers will not sit on the sidelines if the markets hit self destruct. Of course, economists of the Austrian school would say the Feds are not allowing the economy to self construct, rather than self destruct. But, whatever your economic persuasion, this collectively expansionary central bank posture is supportive of asset prices in the short to medium term.
  • There has been an up-tick in economic data (especially growth, jobs and ISM out of the US) in the last few weeks.
  • Inflation in sensitive, emerging growth drivers such as China and Brazil is subsiding.
  • Volatility, as measured by the VIX, for example, has subsided significantly – options are priced much lower than they were only a couple of months ago.

Risks And Opportunities for 2012

• Wherever there is risk there is opportunity and wherever there is opportunity there is risk. Without being too specific, here are some themes, risks and potential black swans to watch out for in 2012. Let me just list a few things I’ve been thinking about over Christmas.
• Macro Themes:
  • The Extinction of Triple A rating – see comment from Part 1 on 2nd Jan 2012. Look in particular at the refinancing profiles the Eurozone faces – which was in my Chart of the Day in that article. But ZeroHedge point out that 2012 is going to be a rather monumental year for debt refinancing in the World with a whopping $8 Trillion coming due – see my Chart of the Day for debt profile of G7. The bond markets can only digest so much – can you spell PIIGS in the Python?
  • Global Inflation – Economic “Monetary Global Warming” – see comment from Part 2 on 3rd Jan 2012
  • China Economic Transitional Control (soft versus hard landing). My prediction here is that it will be managed as a soft landing, but a “landing” never-the-less and landings rarely happen without a bump or two. Expect tails for investment in the Greater China to remain fat and continue the trend they started in 2011. Expect defaults to be contained (not systemic/contagious) credit-based investments in Greater China will be an increasingly dangerous minefield to navigate – rising frequency/default rates and uncharted workout/recovery rates.
  • Property Prices. Two prominent property markets at very different stages of their cycle. In the largest economy in the World, America, inventory overhang is still heavy but towards the end of the year look out for signs of property prices bottoming out. In the largest population in the World, China, look out for signs of a treacherous bear market in property – especially at the mid to high end residential.
  • Election and Politics. Start with the obvious, the Republican primaries are heating up in a big way. Then there will be almost no respite as this momentum will feed directly into the general election frenzy. This sets the backdrop for the politicization of the investment horizon. Expect some assertive rhetoric directed towards sensitive issues such as Iran/Israel, China and, of course, the domestic economy/deficits/regulation. See comment from 1^st Jan – Politics Will Dominate. Layered on top of this backdrop are the, rather tense, Russian Presidential elections (March), the French Elections (1^st Round in April, second round in May). Note that Sarkozy is already throwing his political weight around, first with unapologetic finger pointing at Britain and then with very aggressive rhetoric towards aggressive rhetoric towards Syria. Finally add in the small issues of the 12^th 5-year plan and a complete leadership overhaul in China’s Communist Party leadership and a US presidential election in November! There is literally no time to catch your breath – the markets will watch these events and the policy rhetoric leading up to them very carefully.

• Potential Black Swans:
  • Eurozone: still the biggest black swan out there. Eurozone break-up will be very painful and is currently represented as a distinctly “non-zero” probability by the markets – as Michael Platt points out. There are rumours that Spain may already need to tap the EFSF. A fund created by Europe to save Europe which already faces a downgrade from AAA in lock-step with France – you couldn’t make this stuff up! European politicians may have bought some time but they haven’t bought much, the bond markets will soon call for detail on Treaty Change progression and a fiscal reform timetable with specific deliverables.
  • Political Surprises. Take your pick: French election unveiling unexpected Euro-skepticism. Putin getting “overthrown” before he’s even re-elected. Ron Paul emerges as a viable front-runner in the Republican Primaries (I will not get drawn into a political argument but suffice it to say, the market is not pricing this probability in with mainstream media dubbing him the unelectable candidate).
  • Return-Free-Risk Instead of Risk-Free-Return. Markets are determined by sentiment – even the most liquid bond markets are no different. A sharp sell off in one of the major bond markets (for example Treasuries or even Japanese Government Bonds) will have huge repercussions to the global economy.
  • Geopolitical. How strong are North Korea’s Kim Jong Eun’s relationships with the remaining political cronies of his father? How much authority does he command over military leaders? How will its relationship with its sole ally, China, evolve? We’re about to find out in 2012! The unpredictable regime has already started lashing out at its neighbour to the East. Don’t be duped into thinking that Iran has been contained either – the sanctions are having effect and the threats of a war in the Straits of Hormuz are empty… for now. But there is deep anger simmering beneath the surface and Ayatolla Khamenei rattles sabers primarily to distract from a very desperate and unstable political structure and an increasingly agitated Iranian public. This situation is far from stable. Elsewhere the Arab Spring shows little sign of abating with Syria on the brink of civil war and Egypt facing a tense transition to democracy.

Chart of the Day

G7 Aggregate Debt Profile (Source: ZeroHedge)

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