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2012 and the Politics of Debt.


A colleague tells me the current environment is not about investing anymore – it’s about the politics of debt. Investors have watched as a ‘macro broom’ has indiscriminately swept aside all securities without regard to individual stock and bond attributes … for 3 years running. And …

<img src="Italy IOU.jpg" alt="Italy bond debt" />

Politics will dominate in 2012.

A J.P. Morgan report says that investors have seen recent elections in Spain and Egypt and can look forward to elections in Taiwan, Finland, Russia, Hong Kong, South Korea, France, Mexico, Venezuela, China and the U.S. in 2012. For fun, add in a ‘Kim’ change in North Korea and then German elections in 2013.

Further, elections impact regulatory, fiscal and monetary policies that reach beyond borders. U.S. elections always impact Canada and Mexico. European elections will shape resolutions to the continuing Euro debt crisis. (Europe will look very different in a few short years as the magnitude of their challenges extend beyond finance into sovereignty, cultural identity and values). Egypt will influence middle east politics. Oil producers Venezuela, Libya and Russia may encourage higher oil prices – the incremental revenues used to buy social stability. Higher oil prices can’t be good for a fragile global economy on the mend. (Ex-Alberta).

These countries represent about 50% of global GDP … surely, 2012’s elections will impact economies and investment markets.

Politics will impact macro trends.

Whatever the eventual election results, the macro environment that politicians (and investors) face in 2012 include uber-low interest rates, high debt levels, high unemployment (leading to social unrest), corporate profits flat to down (not up), pressure to cut government spending (more social unrest) and the prospect of increased taxation. If oil and commodities prices don’t behave, then maybe add some inflation to the mix. The nightmare scenario for all is an unanticipated increase in interest rates as bond buyers demand more compensation for risk at the same time as a slow or no growth economy.

Given this backdrop, will there be investment opportunities in 2012?

Volatility.

The politics of debt are likely to cause periodic market distortions as ‘hot money’ investors respond to news with mindless panic. When markets disconnect from corporate fundamentals, there can be opportunities for longer-term investors. Bond holdings can become profit positions and stocks can go on sale.

Valuations.

60% of European companies are currently discounting no earnings growth … in perpetuity. How can investors not value future earnings? In the U.S. auto sales, home building and inventories are all running across the bottom at recessionary levels. A further downturn is likely to seem more like jumping off the first step as opposed to walking off a cliff.

Timing.

The technical guys say that the risks of the Euro situation are so bad that those risks cap the potential upside of the S&P 500 at about 1250. (That’s where we are today). But economic indicators are running at recessionary levels making valuations look compelling and this places a floor under the S&P 500 at about 1050.

So, as the S&P 500 corrects down through 1100, rebalance. Reduce exposure(s) to bonds (sell high, take profits) and add exposure to stocks (buy low).

Next time?  More Risk Management.
Doug Cronk CFA is Manager, Investments for a Canadian Pension Plan
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