The Investment Climate for 2012
The tumult and uncertainty experienced by financial markets in 2011 appears likely to continue this year as well. As discussed in my prior newsletter, macroeconomics and politics, dominated by the problems in Europe, have been the primary factors for the volatility in the financial markets.In global equities markets where many exchanges experienced 15-25% declines, only dividend paying stocks provided some refuge from this deterioration.
The sovereign debt concerns in Europe continue to be the dark cloud hovering over the markets. While some analysts believe that the necessary steps have been taken to alleviate this crisis, I remain unconvinced. With the possibility that the European Economic Community (EEC) may change or even collapse creating chaos in financial markets, it is imperative for investors to hedge their portfolios by including alternative investments and strategies. Many banks and institutional money managers have already begun the process of analyzing possible ramifications of this scenario with the ensuing conversion from Euros back to national currencies.
One of my chief long-term concerns is the possibility that accelerating inflation will become yet another problem. Should the US and Europe continue to print money, I believe there will be a day of reckoning when confidence in the real value of the currencies will be called into question. History buffs may recall viewing photographs taken during the 1930s in Germany's Weimar Republic of wheel barrels of money being carted off to a bakery to simply purchase a loaf of bread. While I don't believe hyper-inflation of this magnitude will result, investors do need to protect their investments against a sudden increase in inflation.A significant risk in an inflationary economy would be a rapid rise in interest rates that would devastate bond prices. For investors concerned about the renewal of inflation, historically a risky strategy would be to continue to invest in US Treasuries with yields at historic lows. While commodities generally performed abysmally in 2011, they do represent an asset class that has historically responded very favorably to heightened inflation.
In my opinion, a key to preventing precipitous declines in managed portfolios is the deft application of both derivatives and short strategies. In the recent past, many portfolio managers were mandated to invest long, that is, investing for capital appreciation, and had little or no room to hedge risk if markets experienced drastic
downturns. Thanks to the easing of restrictions by the SEC to broaden access to these strategies for the general public, investors now have the ability to access high profile successful managers formerly available only to high net worth individuals.I strongly believe that the employment of these strategies will be essential to pursuing superior portfolio performance.
Some anomalies resulting from last year's turmoil have created investment opportunities.In particular, emerging markets equities took a beating while emerging markets bonds declined as investors sought refuge in less risky US Treasuries as the problems in Europe unfolded. With price earnings ratios averaging in mid single digits, emerging equities stocks appear to represent the optimal growth opportunity in the global economy. And much like municipal bonds rallied following a severe decline a year ago, I believe that emerging markets bonds are posed to experience a similar recovery.
In summary, 2011 was an unnerving year where many time tested investment axioms were discounted. As a result, unless a portfolio was comprised primarily of US government bonds, municipals and dividend paying stocks, it experienced negative returns. It is likely that 2012 will present similar surprises.Keys for investors to navigate these waters will be the aforementioned flexibility to adapt to this uncertainty and the willingness to take advantage of beaten down securities in selected asset classes. In the long run, the value of securities is based on underlying fundamentals, but the current climate of fear and uncertainty will continue to present both challenges and opportunities to investors.
As usual, I welcome all questions and comments.
Clifford L. Caplan, CFP®, AIF®
In The News: In late November, I was quoted in an Associated Press article circulated nationally titled "7 Year-End Tax Tips for Mutual Fund Investors".
Past performance is no guarantee of future results. International investments are subject to risks not present with domestic investments. The main risks of international investing are currency fluctuations, economic or financial instability and lack of timely or reliable information or unfavorable political or legal developments. Derivatives and short strategies are complex and high risk investments. Please contact me or your financial advisor for more information.