“Markets today are ‘one big giant ETF’ (Exchange Traded Fund).” -Joe Saluzzi of Themis Trading in New York on Bloomberg TV 21st December 2011
Over the last few years there has clearly been a disconnect in capital markets between how stocks should behave based on solid earnings numbers and the short-term behaviour of traders and market makers who appear to be often in a different universe to investors and money managers. The interview with Joe Saluzzi confirmed my suspicions that computer generated trading based on algorithms has now created a tail wagging scenario that is unhealthy for capitalism.
The interview comments on the thin layer of liquidity in capital markets, the influence of circuit breakers, hyper-second trading, the lack of IPO’s and concludes that another ‘flash crash’ (defined as a quick 10-15 minute correction of >10%) as witnessed on 6th May could indeed occur quite soon. All the hallmarks for this are in place as the world focuses on the EuroZone and its difficulties. But there are, of course, other possible black swan events out there such as Iran or North Korea (some more sabre rattling is predicted with their cousins in the south) as well as a harder landing for China. The year 2011 indeed was a very dark year for investors (even Buffett’s Berkshire Hathaway was -4.7%) but I doubt 2012 will be that different. Of course the thought of 50% of The Beatles (possibly) opening the festivities at the London Olympics might just freshen up investors later in the summer but some nasty events could occur in 1 H 2012.
As I write the bankers at UniCredit in Italy are undertaking a 43% discounted Euros7.5bn rights issue. Their timing surprisingly is quite good as markets are currently looking for some New Year ‘Vim’ (Latin for ‘strength’, hence the old advert adage “Vim gives new strength to your wash”) but of course the real reason relates to what is and has been happening in bond markets over the festive period.
Most main parties in the EuroZone have tested the waters ahead of what is likely to be a problematic period. To date Germany, Spain, France & Italy have already issued some bonds ahead of the bigger roll-overs scheduled mainly for February/March. The big question though is whether the current yields of 4-7% offer investors ample reward and whether these roll-overs can get filled. Any further hiccup in the EuroZone could easily send potential investors to the sidelines and continue the Euro’s slide into eventual oblivion. As an aside I saw one shop on my local French channel just last night accepting the ‘old’ french Franc from customers; maybe they know something markets don’t! Again as I write this an email has just dropped in from an institutional contact in Geneva suggesting that Greece has threatened to exit the EuroZone within 3 months unless Euros130billion as promised in October is forthcoming. It’s already hotting up then!
A lot of what has already been discussed throughout 2011 and beforehand is coming to a head. The predicted second banking crisis still appears to be around the corner as especially EuroZone banks try to strengthen their capital ratios ahead of Basle. Sarkozy and Merkel seem to be continuing their dinner dates (much amusement on YouTube) and politics again seems to be taking the spotlight away from the economic reality show. In the EuroZone negative growth is forecast (France 1 Q 12 estimate is -0.1% GDP contraction) whilst in UK a trawl along the bottom is likely as consumers feel the pinch (just look at Next today).
The recession continually being discussed in the media appears to be here already. The old derivatives timebomb is still ticking as the global exposure again reaches US$700 trillion. The issues over credit ratings never disappear with France on permanent watch; how long can it be before the 3 main agencies sharpen their swords on France and Spain? There is ,however, some sparkle in the US economy despite the 8.6% official US unemployment rate (15-20% unofficially); the consensus S&P forecast does look encouraging though at +7.2% but these same forecasters got most of their 2011 forecasts hopelessly wrong. Having said that the US$ greenback and markets do provide some short-term protection from the Euro & £sterling although nothing whatsoever tempts me to buy US Treasuries on a yield below 2% (against inflation of circa 4-5%) and a budget deficit of now alarmingly US$15trillion +.
Indeed the only credible and sensible investment themes for 2012 are to continue to buy gold in one form or another, oil shares (I still expect some rotation out of Royal Dutch Shell into BP and other majors at some juncture), Africa and other emerging markets (I particularly like Russia and Brazil in preference to India and China), solid international investment trusts, New Capital Wealthy Nations Bond Fund (over 7%) and up to 25% holding cash (in a mix of currencies in addition to £stg & US$) but avoiding the Euro at all costs. The oil price could be the surprise package this year and could trade in $85-120 range; any fall hereon could well kick start the US economy and ignite already moderately positive US earnings which is why forecasters are bullish. I’m not convinced by this argument though which is why I prefer to remain relatively liquid. Our friends in Iran could well throw a spanner in the works if the current aircraft carrier jibes are anything to be taken seriously…which they are.
It remains to be seen whether the EuroZone, the ECB, the IMF & EFSF (European Financial Stability Fund) et al can work efficiently together and possibly gain enough momentum to raise enough Euros to bail the debtors out, in the right order. It’s possible that up to Euros3trillion could be QE’d but this must be done in cohesion without individual sovereign and bank failures.
With regard to stock selection amongst the oil majors I still continue to look to buy Royal Dutch Shell at closer to £16-20 & BP on dips nearer £4. Amongst oils I like the look of Ophir (having taken over Dominion), Exillion and even possibly Essar provides some value here. Vallares are now Genel and are out of favour in the short-term; more excitement from Hayward and Nat Rothschild though is expected. All the smaller explorers such as Soco, Hardy O&G, Premier Oil and Heritage should start to respond as the year progresses. Amongst gas stories I like Encana at under $20 and notice that there is some impending excitement amongst other Canadian gas plays (Edge Resources is due to arrive on AIM shortly).
Elsewhere in FTSE as usual I am extremely cautious although some previous targets to buy at have been reached. I’d prefer to look at BAE Systems nearer 260p, GlaxoSmithKline nearer £13, Sainsbury nearer 265p, HSBC nearer 460p and Standard Chartered nearer £12. My preferred 2011/2012 tip is the inter-dealer/broker Tullett Prebon and at 271p yielding over 5.7% this is still a compelling buy being a possible takeover candidate too. Selectively an investment trust approach seems more prudent and investments in JPMorgan Claverhouse, Henderson Far East, Schroder Oriental, Securities Trust of Scotland and Merchants Trust are still compelling for income investors whereas emerging markets trusts such as JPMorgan India, JPMorgan Brazil, JPMorgan Russia and BlackRock Latin could also be considered.
There isn’t a suitable trust for the Final Frontier, Africa so a selected basket of equities is preferred here. In particular I still like Randgold, African Barrick, Afren and Shanta. Elsewhere globally I am still persevering with Patagonia Gold, Orosur, Peninsular and Anglo Pacific remains a classic royalty play that provides some variety. As far as the rest of the UK market is concerned I’m being very selective and prefer international equities.
With sideways volatility again expected during 2012 I continue to encourage portfolio weightings such as 0% Fixed Interest (a bond implosion is forecast), 20-35% cash, maximum 80% equities (overseas earners mainly incl. 25%-40% in precious metals stocks, a spread of investment trusts). Again it’s important to restress that investors are entering an era where stagnant growth (& contraction) in the west could be offset by continued growth in emerging and frontiers markets. The correlation between deflation and inflation needs to be watched closely which is why there’s a growing case for increasing equity exposure especially on any decline across markets. The level of the coming decline is the key and I still feel that 10-30% is possible which implies 4,450 on FTSE100. I think we are about to witness the SPUTNIK MOMENT as has already been predicted. The contrarian view of course is if the EU & US manages to convince markets that a continued bumbling QE practice should be the order of the day. If that happens then expect a much higher S&P and a similar review this time next year predicting the demise of the Euro (again). There are alarming similarities with 1930-1933 which are coming to fruition.
If the Liverpool likely lads do put on a prescribed sensation at the Olympics opening ceremony then Team GB can do no wrong even if no Golds are achieved.