These themes guide our investing in 2012

Author: Tom Yorke, Oceanic Capital

Covestor models: Global Diversified Conservative, Global Diversified Moderate, Global Diversified Aggressive

In reflection, the word that sums up 2011 to us at Oceanic Capital Management [OCM] is “hubris.”  Amazing amounts of it slimed the markets in all corners of the world. We saw it in spades last summer in the USA, on both sides of the political aisle, during the near implosion of the US government (and the – what? – downgrading of Treasuries; who ever heard of such a thing?). We saw a major hedge fund chief, Raj Rajaratnam of Galleon, get sentenced to 11 years in jail for insider trading.  In Jon Corzine we witnessed yet another dude who thought he knew so much – more than the collective wisdom of the markets. He was willing to gamble the future of an entire company (a US primary dealer no less) along with thousands of families’ funds, on a bet that any “line” trader would have recognized as doomed.  Guess what folks? Bad trade.  And we all lost: no more company, no more jobs and, by the way, the clients’ supposedly-sacrosanct segregated funds are now gone.  POOF!  Oh dear, we are sooooo so sorry, good luck next year.

American politicians – we were told by 60 Minutes – seem to come to Washington with relatively modest means and somehow leave wealthy. Offered as evidence was Denny Hastert from Kendall County, Illinois, a former High School wrestling coach, who reportedly arrived in Washington with a net worth of $200,000 and left eight years later worth $8,000,000. (That boy should have been a hedge fund manager!)  Now, I realize that a congressman’s retirement and benefits package is positively Spartan, but somehow I think they will survive. However, Nancy Pelosi opted to supplement hers with nice sale of some Visa shares she managed to get from the IPO just as the house was killing a piece of credit card legislation.  So, I know it’s a shocker, but politicians don’t seem to want restrict these “perks” and haven’t yet rallied around the “stock act” to limit congressional insider trading…..Hmmm seems like hubris to me: you go to jail, and I get rich!  This is the worst possible kind of hubris, it’s appalling,  and we are willing to tolerate it when our political leaders say “Do as I say, not as I do”?

But before you think that we Americans have cornered the market in hubris, let’s turn to our friends in  Europe, where we saw so much it was like the Trevi fountain.  At every possible turn the Euro Pols were in abject denial, and the best we could hope for were more basically empty words (forget deeds), which left all feeling more mystified than satisfied. Between Greece, Italy, France and Germany they raised the game of Kick the Can to an entirely new level. And the hubris continues still today as we await the next “Merkozy” pronouncement. The only (relative) winner in this game so far has been England, with David Cameron seeming to have basically divorced himself from the rest of the continent.  Time will tell whether that is a successful quarantining strategy or  just a formula for marginalization.

Yes folks, for 2012 Europe is still a mess.  The stock issuance by UniCredit, Italy’s largest bank, gave all holders an instant 43% dilution to start the year, prompting the stock to trade down the most it has for 23 years. Given the incredible spaghetti bowl of corporate inter-ownerships in Italy, all major holders of the stock have got to worry about their own stock getting taken to the woodshed. Around the corner, Hungary got downgraded and had a failed bond auction. The ECB is now holding more in deposits for banks than ever, as the banks are concluding it’s best to hoard cash to weather any potential future storm. The topper: investors are now accepting negative returns on German bills, having decided the best they can hope for is the return of their capital, not a return on it.

But hang on folks, we will have some fantastic new words for you shortly. Trust us, it will all be better soon.

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So here we are in 2012 and without a crystal ball we are not making any predictions. But these are some of the themes we see guiding our investments for the balance of the year.

DOMESTIC U.S. EQUITIES, the salt of the earth, rock solid, large moat, dividend paying, cash flow generating stocks are OCM’s asset of choice for 2012. We like companies that have large hoards of cash, competitive staying power and possibly a better credit rating then the USA. Many names have been thrown around for these, but they are generally the best in class and often in very non-sexy businesses. We will likely increase our allocations here as the competing alternatives are just not all that alluring.

GOLD – Although we were definitely disappointed about the volatility in the gold market this past year, it ended the year up about 11%, although well off its intra-year high, hit in August. Our global/macro perspective on Gold just hasn’t changed despite the decade-long rally. Things are just not looking good in Europe (or the USA for that matter) regarding debt levels of both key financials and sovereigns. The only logical way out will be for the various sovereigns to continue printing money to pay for everything and we see that as supportive of Gold prices.  A significant allocation is mandatory for a properly defensive portfolio.  That said, the far-sighted investor will be ready for continued volatility in this position as Gold – being a very deep and liquid market – will always be the first choice of margin clerks looking for liquidity to cover margin calls in times of crisis.  Given the financial shape of Europe, the precarious state of the larger national banks and the potential domino effect if one should actually fail, we must position ourselves defensively. That means Gold.

EUROPEAN EQUITIES are bit of a quandary; it would seem with Rome burning and “Merkozy” fiddling we should be running for cover. Certainly the financials won’t be too tempting for a while.  I suspect we at OCM will keep things about unchanged without any deepening allocation.   However, remember the problem in Europe is that we are still in the “word stage.” If positive deeds start occurring, or when the markets stop the violent down trades on bad news, we may look to change things here slightly by increasing the allocation.

EMERGING MARKET EQUITIES – We feel a little better about many of the EM countries, having suffered substantial pullbacks and in the case of the Brazilian Bovespa already up 5 % for the year. Over the years, the emerging markets often significantly outperform, both on the upside and the downside. We can easily see increasing our allocation a bit here as things begin to get a little better. Our feeling is that a few of these countries will respond quickly and well to any sort of pickup in economic activity in the USA, even just a moderate base line growth level should help them get their footing. This should help them regain their leadership role in the global growth race.

US TREASURIES– I think we all learned a lesson this year when it looked like this asset class was a lay up to underperform, perhaps significantly. Count me among those surprised when it continued to rally even after Bill Gross and PIMCO, (still the world’s largest bond fund) finally threw in the towel and surrendered. After all, the US tenyear note started the year at 3.25% yield and it looked precariously perched at the edge of a cliff, with interest rates destined to go nowhere but up. It just goes to show how wrong even we “smart guys” can be. The ten-year note promptly rallied another 1.25 basis points to end the year yielding about 2.0%. Next year what do we expect?  Hey, a 1.50% ten-year note doesn’t sound that far-fetched after all and given our current World-in-Crisis mode and the Fed’s desire to bring down long term interest rates, maybe it’s not too crazy to expect ten year notes to hit 1.25 to 1.50%.

FOREIGN EXCHANGE – The “easy trade” would seem to be short the Euro and come back next year, but when everyone likes an idea it’s probably time to stay away (or least be ready to skedaddle very fast). We think keeping some positive dollar exposure given the constantly reappearing Black Swan makes a good bit of sense and possibly more sense if the US ten-year note continues to rally. The dollar seems to hold its negative correlation in times of crisis very well as the short-dated T-bill market gets a strong bid and the dollars follow. It provides a nice offset to declining equities prices, but in lower rate environments there is a floor on how much Treasuries can rally, whereas the dollars could continue to rise.  We are cautious on FX assets right now.

OIL seems like it will vacillate from crisis to crisis, whether it’s due to a lack of refining capacity, continuation of the Arab spring uprisings, or Iran’s closing the Straits of Hormuz. Natural Gas seems to be well supplied, with new discoveries coming out of the U.S constantly. The U.S. shall soon be a net energy exporter again.

In essence, we expect 2012 to be more of the same in terms of predicting exactly what’s going to go up or down, and by how much. They are low probability bets at best, likely impossible, but more likely hubris. We expect market timing to be exceedingly difficult at best, but more likely financially life threatening and not necessary. We will soldier on looking for our efficient frontier where our own risk tolerances meet expected returns – in a phrase, remaining cautiously optimistic. We expect not to hit the highest high, but know we need not as long as we protect ourselves from hitting the lowest low.

Finally, Happy New Year from Oceanic Capital Management.  Thanks for checking in with us.