Happy New Year! May 2012 bring you and your family good health and good fortune.
2011 was a tough year to make money in the markets. It was not like 2008 when many investors dropped half their net worth, but with interest rates near zero and a variety of world events, 2011 was a volatile one. Japan suffered an earthquake, tsunami and nuclear meltdown. Greece reached the brink with other parts of the Eurozone slipping with it. The United States Treasuries were downgraded – no longer rated AAA. The Arab Spring brought six Arab countries into civil wars. We entered a new war in Libya while leaving Iraq and we ended the year with Iran beating its war drums. Even once dependable China spent the year purposely slowing their economy, wrestling with an over-built housing and office market. After all, the S&P 500 ended the year, roughly flat, but 8% below its April 29th high. Even those numbers overstate the market performance since the 16% gain between October 4th and October 28th was one that few investors realized since most were heavily cash after a five month market decline, culminated by a September which saw the market drop by 10% in that month alone. Hardly a scenario that sounds good for investors?
The good news: Many of the storm clouds of 2011 may soon dissipate. The week before Christmas, the ECB (European Central Bank) granted over $600 billion in three-year loans to European banks and loosened the collateral requirements that banks use to qualify for ECB loans (and to be considered solvent). The plan is referred to as the Long-Term Repo Operation (LTRO) and indicates that the ECB has found a palatable (to Germans) plan for printing euros. I believe the LTRO will actually help. Very encouraging considering the ECB track record of talk, but no real action. The LTRO allows banks to borrow at 1% and invest that money into their own nations’ treasury bonds. It should help reduce the borrowing costs of their respective governments, while offering the banks a (no additional) risk way of making a 4% or more return on the borrowed funds. I say there is “no additional” risk since the major banks of Italy, Portugal and Spain already have huge exposure to their government treasuries. If their treasuries blow-up, the banks are toast, so helping to prevent such an occurrence while making an attractive return, seems to be a win-win. The plan worked here, so the ECB has resigned itself to copy the U.S. plan of quantitative easing – allowing for the printing of euros on an “as needed” basis.
The LTRO indicates the ECB commitment to keeping the eurozone united, so it becomes less likely that even Greece will be eliminated. It certainly bodes well for Italy, Spain and Portugal which until now, appeared in danger. The investment opportunity will become clearer once we see a few treasury auctions in these same countries. Lower rates will reflect the program’s success and that would bode well for all markets.
China
China spent the end of 2010 and most of 2011 stepping on the economic brakes, raising interest rates five times and bank reserve requirements eleven times. But on December 5th, the China Central Bank (PBOC or Peoples Bank of China) lowered the reserve requirements for the first time in over three years, indicating that they are satisfied with their inflation and property numbers and are now more concerned about stimulating their economy. I expect another reduction this month, ahead of the Chinese New Year, and likely more to follow. The PBOC favors reserve requirement reductions over interest rate reductions because they believe they are better able to direct the effects to business rather than residential real estate. As China eases, it will stimulate their economy, likely keeping GDP growth above 8% for 2012. This would be bullish for businesses selling to Chinese companies and consumers, regardless of their domicile.
U.S.A.
U.S. companies as a whole are in very good shape right now. Though stock charts may not reflect it, most companies spent the last few years getting lean and profitable, while many are now trading their shares at very attractive valuations. Once investors begin to wrap their beliefs around the ECB plan, these shares could takeoff. Add a stimulus via China’s lowering of the bank reserve requirements and we may see a 20% or better rise in our portfolios, which are complete with the companies which should benefit most.
Possible Political Kicker
2012 might even bring a real jobs bill via an energy plan. I never count on politicians (of any stripe) to do the right thing, but this is one that almost everyone would favor and it would help the lower incomes the most – not just here, but everywhere. It might happen – election years have a way of getting politicians to get something done.
Adopting an energy plan based on the incredible abundance of natural gas, would create hundreds of thousands of jobs, would decrease the cost of oil for Americans and all other nations. Reduced costs for gasoline and heating would free-up money for reducing debt, saving, and for the purchase of discretionary products – a global stimulus plan that would vastly increase tax revenues without increasing tax rates. The United States is the Only major nation without an energy plan. We are the Saudi Arabia of natural gas – a clean burning fuel that costs less than 1/4 that of gasoline. The program would almost eliminate the US trade deficit, would put much more than the $80/month that the payroll tax reduction provides American workers and instead of robbing Social Security, it would add to the Social Security funds. The resulting drop in the use of oil would make the environment cleaner and make the world safer. Oil would likely drop below $70 per barrel, making the funding of terrorist groups difficult if not almost non-existent as Arab countries dealt with a drop in net income by half or more. That would reduce the costs of defense for us and our allies, allowing countries to reduce their deficits and debt from savings and the additional tax revenue. A natural gas energy plan would spur the economy and the markets in many ways. We will not count on this, but when this finally happens, portfolios will have an incredible bull run.
Frank
Ph. 512.345.6789
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