As always with IAP, “reviews” are more about the future than the past. However, we believe you cannot know where you are heading without some appreciation from where you have come. And we believe those providing advice should have some accountability. So, before we offer our guidance for 2012, let us take a quick look at 2011 and how IAP faired.
To begin, there are several myths we need to dispel. One, the markets generally went nowhere in 2011. Two, everything moved in unison and there was little value in actual asset selections. These were recurring themes by investment “experts” throughout 2011 and at year end. As to the markets going nowhere—true, the S&P index was about even. But from peak to trough in 2011, there was over a 20% movement. Everyone appreciates that volatility existed in 2011, but likely did not realize how much “opportunity” existed for the quick and nimble. That clearly supports the consistent IAP advice to not have a buy and hold mentality. Regarding little value in asset selections, Barron’s recently reported that “eight of the 30 stocks in the Dow Jones Industrial Average rose or fell 20% or more last year, but the average barely budged.” Meaning asset selection even amongst just 30 large cap equities was important, let alone diversification amongst equities in general, fixed income, alternatives, etc.
IAP advised throughout 2011 to be cautious; to focus on large cap, dividend paying equities; to be nimble; to not swing for fences, but take smaller percentage positions in holdings that we favored; and to be prepared for active management of volatility. IAP guided on movements in volatility with our internal technical analytic tools; equity markets generally followed technical moves in 2011. We suggested buying fixed incomes but keeping durations short. Our guidance was LOUD that 2011 would not be a break out year for equities, but that opportunities did exist with certain securities. And we steadfastly suggested AGAINST buying bank stocks. Perhaps these results had a degree of luck, and this past performance does not guarantee future results. But we would add this is evidence that active management, with the right advisors, might represent a good value proposition.
So where does that leave us for 2012? Our sense is that many peers believe there will be a recovery in equities—indeed, that has already begun—and 2012 might be the time to be more aggressive. IAP does NOT share that view. With so many headwinds from Europe and China, we believe it is more than likely that even the nascent U.S. recovery will stumble. Our “optimism” that the U.S. federal and state governments will continue with some degree of austerity only contributes to the short term problem. Added to our continued view that the U.S. housing market will not recover, we are left cautious AGAIN for 2012. As we suggested in 2011, there will be a major premium for correct asset selection and timing.
Major themes from 2011 still need to be answered. The restructuring of European debt has seen little progress, thus far only keeping the weaker countries from defaulting. Still unanswered is how to make these countries competitive when constrained by HUGE entitlements and a common currency. Europe ended 2011 with the start of an economic downturn that will probably grow more pronounced, as, we believe, will many of the Asian economies. They have seen a deceleration, as their customers—developed countries—import less. Combined with their own overbuilding and the steady increase of debt, it is easy to see these economies slowing further.
Even the United States, which appeared to be gaining momentum at the end of 2011, will be challenged in 2012. Our view is that the growth in late 2011 was significantly influenced by reduced household savings, increased household borrowing and increased business inventories. Together with the troubled housing markets and the lack of confidence in our political system AND AN ELECTION YEAR, there does not appear to be a catalyst to stir growth through mid year.
On a more positive note, energy costs have retreated and are creating more disposable income for consumers. Lower energy costs and less than vibrant economies will help keep inflation and interest rates in check. This all supports more favorable valuations on PEs. It is the growth, or even sustainability, of corporate earnings that will require close attention.
With this macroeconomic background, income is a continued theme that will be important for total returns in 2012. Spreads have widened in corporate bonds, making them even more appealing. Preferreds, MLPs and higher yielding equities will continue to reward. We, again, suggest keeping durations short in government bonds as you are not being rewarded for the rate risk. As to higher yielding equities, be aware of companies that can increase earnings in the noted environment, e.g., participants in industries such as consumer staples, healthcare, telecom and utilities. Despite these themes being played in 2011 and the run up in valuations, we continue to like companies such as AT&T, Verizon, Abbot Labs, Duke Energy and Shaw Communications, as just several examples.
Like last year, the markets will likely react to news even though little is being done to structurally improve things. Take advantage of this; trimming positions that become overpriced. Liquidate longer term government bonds when they rally (30 year bonds at less than 3%), redeploying into higher yielding corporate bonds. Most importantly, stay diversified. Look to decrease risk and volatility in your accounts. Well structured alternative investments have accomplished this over time. Alternatives did not perform especially well in 2011; most likely all the better for returns in 2012.
We will update our formal IAP positions at mid-year.
This represents the opinions of the author as of January 25, 2012 and is subject to change at any time due to market or economic conditions, or other factors. Statistical data derived from third-party sources is believed to be reliable and has not been verified by Indie Asset Partners, LLC. Specific recommendations contained herein may not be suitable for you; please contact us for recommendations specific to your situation.