Author: Paul Franke, Quantemonics
Covestor model: Relative Value
From a long-term perspective, a list of problems are currently being ignored or discounted incorrectly by Wall Street investors and government leaders. The odds of a major bear market decline in 2012 are considerably higher than normal. Despite the latest May-June market decline of 10%-12% in the major U.S. stock indexes, substantial and abnormal downside factors will continue to weigh on stock valuations and company profits into 2013.
Our reasoning is based on the four icebergs we have to face into January 2013: 1) the still “growing” European sovereign debt and banking mess, 2) the expiring clock on stopping Iran from developing nuclear weapons, 3) the automatic cuts coming to U.S. federal spending in late-2012, and 4) the end of the Bush Tax Cuts for the rich and middle classes in December.
If we hit just one, the stock market will have troubles; if we hit two or three, watch out for sizable downside in pricing. In my 26 years of stock investing, I cannot remember a similarly long list of problems the economy and markets must face at the same time.
Basically, from a big picture, macroeconomic perspective – the stock market advance since early 2009 has been assumed to be built on a regular, sustainable economic advance. However, the foundation of the nearly 100% stock rise over 3 years has been built on quicksand, in our humble opinion.
The 13% annual total of trade and fiscal deficits of GDP now required in 2012 to keep the economy from moving backwards is a huge hurdle in reality, getting harder and harder to sustain much longer. By our math a truly “sustainable” U.S. economy is 15%-20% smaller than the current variety.
The present level of massive government intervention in the markets and economy will not be a permanent answer for America’s ills – and is truthfully aligned closely with socialism at the expense of free markets and freedom generally. What kind of society and nation do we want following this path? We continue to trade away our children’s long-term economic future to maintain out-of-control spending patterns. When will it end?
However well-intentioned in design, socialism is destroying the middle classes on the planet, democratic institutions, free markets, efficient societies, plus innovation and wealth building around the globe.
I remain fascinated that Western economies are dropping capitalism for socialism and witnessing economic growth plunge, while nations like China are dropping socialism for capitalism and witnessing extremely strong economies!
Without serious austerity in America and a smaller sustainable economy, all could be lost in the coming years. We cannot escape the “pain” hitting Europe now either, and I have been screaming for years the borrow/spend stimulus scheme of the experimental magnitude since 2008 by western economies was a crazy, open-ended idea, having no legitimate exit strategy.
Ponzi-like money printing by the Federal Reserve bank and fiscal deficit stimulus at every level of government (city, state, federal) are keeping the fiction alive – namely all is well. What corporate earnings outlook and economy will we have when we try to honestly rebalance the economy’s size? Either through inflationary cost of living increases or lost jobs and higher taxes, tens of millions of additional families will not be able to pay their bills or feed themselves soon.
Unfortunately, 2012 stock market valuations are built on an economy that isn’t sustainable at present levels, in any way, shape or form. The U.S. government and central bank charade may be close to ending. Be prepared for serious volatility the rest of the year in the markets. We are Greece x 50 in terms of our debt problem, as a measure of magnitude and ability to change course.
Stock investors need to understand we are still years away from business as usual. We are confident that hedged and diversified portfolios, like we are running on Covestor.com, will continue to be the smartest design for investors to keep their wealth and make profitable gains over time.
