Download 1st Quarter 2012 - McBrearty Capital Management

MCM
Market Quarter
January 2012
2012 is here! Thank goodness that 2011 is over. Last quarter we suggested that there
were four scenarios that could positively affect the markets:
1. Europe solves its problems. (It didn't happen)
2. U.S. Government takes action. (It didn't happen)
3. Large profitable companies begin to put cash to work. (It happened a little)
4. Corporate earnings increase by expected 15%. (some increased but most were just
slightly positive.)
The 2011 results were as follows for the broad indexes:
S&P500
Large Cap
Mid Cap
- .02%
-4.40%
-4.60%
Small Cap
Nikkei 225
-9.10%
-17.34%
EuroStoxxSO
Gold
LT U.S. Treasuries
TIPS
Investment Grade Bond
High Yield Bond
-18.41%
10.19%
30.25%
9.28%
5.17%
-.78%
So with these less than mediocre results, where do we see recovery and growth.
Emotionally we are looking for something that will make us think positive. 2012 has a
lot of issues to be faced. The Global Economic Forecast below is a good representation
of what many economist foresee for 2012. This forecast was presented by Dr. Jerry
Webman, Chief Economist for Oppenheimer Funds.
Economic Outlook
Global Economic Forecast
U.S. Corporate Sector
The health of the corporate sector is as sound as it has been in decades as businesses are
generally flush with cash and are maintaining fortress-like balance sheets. Earnings estimates
are likely to moderate in the coming months, but U.S. businesses remain well positioned to
take advantage of opportunities in the world's stronger growth regions.
U.S. Inflation
Commodity prices remain elevated, but core inflation (ex-food & energy) is well within the
Fed's perceived "comfort zone." Despite the sizeable expansion of the Fed's balance sheet, the
vebcity of money remains muted. Modest inflation rates provide cover for potential further
policy accommodation.
Emerging Market Inflation
Aggregate inflation pressures have receded following a year of tighter fiscal and monetary
policies in many emerging economies. The maneuverability within select emerging market
countries to now ease policy conditions will help prevent growth from grinding lower.
Interest Rates
The Fed anticipates that economic conditions will warrant an exceptionally low federal
funds rate at least through mid-2013. The European Central Bank (ECB) has moved to an
accommodative stance and is likely to lower rates further as conditions worsen. Many emerging
economies have now embarked on counter-cyclical policies, easing lending conditions es world
economic growth moderates,
Global Growth
The U.5. economy is resilient, but breakout growth remains out of reach with fiscal austerity
looming and the housing market still impaired. Europe is headed for a prolonged recession
as many countries have enacted crippling austerity measures to appease the bond markets
and to secure additional credit facilities. Growth in the emerging world is moderating lo more
sustainable levels.
U.S. Consumer
A moderately improving jobs picture and low interest rates will help prop up the remarkably
resilient U.S. consumer in 2012. High unemployment and mortgage debt overhang remain
obstacles to faster consumption growth, however,
U.S. Credit
Banks expanded commercial and industrial loans in the third quarter at levels not seen since
2008, but credit growth remains slow. Regulations to promote an adequately capitalized
banking system will prevent the credit excesses of the past decade, but the recent increases in
available credit will help augment U.S. growth.
Industrial Inputs
Prices of many industrial inputs, such as copper, for example, declined significantly in 2011
due to a slowing in many of the world's largest economies. Oil prices will likely remain elevated
amid generally resilient global growth and increased geopolitical uncertainties,
European Sovereign Debt
Policymakers continue to buy time for fiscal adjustments and bank earnings to strengthen
balance sheets, but ending the crisis depends on finding political resolutions that will not be
forthcoming for much of 2012, if at all. Ultimately a tighter fiscal union needs to emerge.
U.S. Politics
Political dysfunction will continue to feed market volatility. The U.S. economy is now facing a
sizeable fiscal drag just as the economy is showing renewed signs of life. Election-year politics
will only add to the uncertainty.
U.S. Housing
The housing market searches for a bottom with home prices now more affordable than any
time on record. The elevated supply of existing homes on the market coupled with the huge
number of homeowners still underwater prevents home prices from surprising to The upside,
2011 will be forever remembered as a year in which events once considered to be
unthinkable became reality. European policymakers have allowed the continent's
sovereign debt crisis to intensify, calling into question the viability of the common
currency. A nuclear meltdown in Japan disrupted supply chains around the world. The
U.S. lost its treasured AAA- credit rating as a senseless debt ceiling debacle of its own
making exposed the political dysfunction in the nation's capital. A series of Middle
Eastern and North African, governments met their demise.
Through all of the above the economy continues to be vulnerable to outside shocks.
Perhaps the most remarkable development of 2011 was the ability of U.S. businesses and
households to persevere and adapt, keeping both profitability and consumption at higher
levels than events may have led us to expect.
Outside the U.S. we can expect China to continue to ease bank reserve requirements
throughout 2012, stemming the recent contraction in credit and reinvigorating activity
in what is already the world's fastest growing economy. The economies that are
dependent on Chinese growth will be the main beneficiaries. See Chart 4.
CHART 4
The Growth of Many Emerging Market Countries
Is More Tied to China than Europe
Top Export Markets for Select Emerging Market Countries (% of Total Exports)
..
Poland: 55.9%
'.' Qirch ft public 66.2-Vi
. Hungary; 56.5%
,
" 'Turkey: ..
3X1V';r'
"'
Mexico;
30.0%
15.2%
... ^..
South Africa:
11.4%
Souice of chart data: Internationsf Merchandise Trade Statistics (IMTSJ, as of 12/14/10.
Note: Export percentages are based on full year 2010 Trade data.
China slowed its economic growth from 9% through restraint. They are now easing that
restraint and expect growth to be around 5%in an inflation controlled economy. It may
very well be China and the other emerging markets that lead the world into recovery.
As one can see the Broad Indexes at the top of this report show the best performers were
Long Term Treasuries 30.25%, Gold 10.19%, TIPS 9.28%, and Investment Grade Bonds
at 5.17%. The Treasuries, gold, and TIPS were so high because of fear. In 1944, Franklin
Roosevelt said we have nothing to fear but fear itself. For 2012 most economists feel that
American investors are no longer fearful, but are just angry, disgusted, and ready to start
pushing forward. We do not expect Treasuries or gold to lead in 2012 through fear.
Chief Investment Officer, Colin Moore (Columbia / Bank of America), Art Steinmetz
(Oppenheimer) and many other bond managers feel that high yield bonds and emerging
market bonds will lead in 2012.
Government Spending
We are beginning the "big" election year. The chart below shows 2011 Federal Finances.
It appears that the total spending for 2011 was about $3.6 trillion. Tax dollars accounted
for $2.3 trillion and $1.3 trillion is new debt.
INSIGHTS
Federal Finances
The 2011 Federal Budget
Federal Budget Surplus/Deficit
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The super committee in December could not agree on cuts to spending. What would you
cut of that $3.6 trillion? Does this knowledge affect how you will vote?
Chart 2 is defined as Political Polarization.
MARKET
Political Polarization
INSIGHTS
Pre*idefiiial Approval Ratwig Over Term Cycte*
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It seems clear that there is not much approval of government by citizens. It surely is
going to be interesting.