2012Jan13 No Resolution

2011 was one crazy financial year. We begin 2012 without any significant resolution to the issues that created headlines and whipsawed the market in 2011.

There’s an old adage about the safest way to commute on a rollercoaster.  Even though it goes through twists and turns, and can even go upside down, it is generally safe and always gets you back to where you started.  Unfortunately, at the end of the commute you have not advanced at all and the ride cost you money. This seems like an appropriate description for 2011. 

While unemployment has fallen slightly, the US economy is replacing high paying jobs with low paying jobs.  Of the people who lost jobs in 2008-09, 52% of them took a pay cut when they found a new job.  Of course, this only applies to those that found a new job, which was roughly 43% of the group. That’s not good news for those who lost their jobs, and it is terrible news for those just entering the workforce.  This pressure keeps wages low. It ripples through the economy in the form of lower spending, less use of credit, and a higher level of debt delinquencies and foreclosures.

The real estate sector has competing forces.  Builders have been selling more new homes, but at lower prices.  This could be the normal outcome of builders sitting on empty land for years.  Eventually, they have to build homes to get rid of their vacant lots. If selling at a lower price is the only option, then so be it. It puts even more downward pressure on existing home prices, which continued to fall in 2011. 

There are, also, approximately fourteen million home owners either behind on their mortgage or in some stage of foreclosure. There was quite a slowdown in the foreclosure process in 2011 as it became clear that the banking and lending institutions had not kept legal records as to current ownership of many residential properties. They are working to resolve these issues with the help of Congress. If they succeed the number of homes put back on the market will increase significantly and add to the downward pressure on home prices.

These issues would generally cause a stall in equity prices. However, there has been an up-tick as companies have posted decent profits.  Among these companies are large multinational firms that earn significant portions of their revenue generated outside of the US.  With Europe on the ropes and China slowing down, the outlook for foreign revenues has dimmed.

Unfortunately, the roots of the 2008 financial crisis have not been fully addressed.  Congress and the Fed have instituted programs to push the economy higher with limited, if any, success.  The same is true in Europe and China.  The secret source of all of our woes is not very secret at all – it’s debt.  We have too much debt in the US. The Europeans are weighed down by it, and the Chinese are just now revealing the massive amounts of debt used to propel their economy over the last few years. Without a clear plan to deal with the debt, any other programs that are being implemented or discussed will have limited positive impact.

 Investing has become much harder in recent years. That does not mean that we can shy away from it.  Now, more than ever, investment discipline and the hard work of research are essential. From our relative strength perspective (trend following, not guessing), we are operating in a negatively trending market interspersed with trading rallies.  With rapidly changing market conditions we stand at the ready to alter our course as required for safety and positive returns.

From a probability perspective (a guess about the future), 2012 could be a year of welcome relief. From the Wall Street Journal: “…years like 2011 are typically followed by big gains in the following year, Jason Goepfert of Sundial Capital Research writes. ‘The median market move following a year in which the S&P gains or loses less than 3% is a 12.3% gain, according to his research… the market is positive 78% of the time.’”