Vigilare Wealth Management Outlook and Strategy for 2013

By Jason@vigilarewealth.com on January 8, 2013 in Investor Lounge

Vigilare Wealth Management Outlook and Strategy for 2013

2012 will be remembered as the year of Central Bank intervention. The massive fiscal stimulus packages of 2009 and 2010 were wearing off, and by the summer of 2012: the U.S. economy had slowed to 1%, Europe and Japan were both in recessions, and China experienced its slowest growth in decades. By the end of May, the Dow went negative for the year largely reflecting this reality, and uncertainty around the U.S. elections and the upcoming fiscal cliff. By the end of the summer (we wrote about in our July commentary) the world Central Banks, led by our Fed and the European Central Bank (ECB), announced new rounds of unprecedented aggressive monetary stimuli (Trillions of dollars!), and the rest is history. Risk investments were rewarded and ended the year substantially higher. The Dow finished up 7%.

Strategy for 2013

Baseline Scenario: 60% Odds

Assumptions:

U.S. political and tax certainty, combined with a modest real estate recovery and clear Fed policy (to create inflation and weaken the dollar) lead to a change in consumer, business, and bank behavior. The psychology of cash “hoarding” reverses (Bank and Business idle cash currently sit at a record $4 Trillion) which leads to more robust business investment and increased lending (from industrial loans to credit cards and mortgages). We wrote about this in our October commentary as being one of the necessary catalysts for a sustainable recovery. In Europe, the recession and upcoming elections pressure conservative Germany into more economic solidarity. Germany green lights an even more aggressive ECB. China’s (under new leadership) focus shifts from inflation-fighting policies to growth and stimulus policies.

Investment strategy in this scenario:

• – Stocks and risk investments up 10% to 15% for the year (overweight cyclical, materials, banks, energy, high 
•   dividends, international, and emerging markets)
• – Bonds have first negative year since 1994. We expect losses of -2% to -5% on the year
• – Inflation would remain elevated and rising
• – Dollar would weaken further, especially against emerging market currencies and gold

Alternative Scenario 1: 10% Odds

Central Banks’ experimental and aggressive policies awaken the “animal spirits” and prick the bond market bubble.

Assumptions:

Money supply rate of growth starts to accelerate too rapidly (with trillions of dollars in excess money supply already in the system) which causes a sharp drop in the U.S. dollar. With a shackled Fed committed to zero percent short-term interest rates, International creditors lose patience and begin to sell Treasuries (International creditors account for almost 50% of treasury holdings) causing long term interest rates to shoot higher.  Unexpected loses on bonds gain momentum as more investors abandon the bond market.

Investment strategy in this Scenario:

• – Stocks and risk investments would be very volatile and return between 0% and 5%
• – Bonds would experience losses similar to the 1970s of between -5% and -20%
• – Inflation could reach high single digits and would even affect stocks that are sensitive to inflation
• – Agricultural commodities, materials, precious metals, and energy related stocks would perform well 

Alternative Scenario 2: 30% Odds

Assumptions:

This scenario is not based on a single event, but on a number of possible “black swans” that could thwart the Baseline Scenario outcome. Sound risk management should always have a set of contingency plans (You never want to be caught flat-footed). What are some of examples to have on the radar? Geopolitical tensions could rise between China and Japan or in the Middle East. China has had a big boon in off-balance sheet financing similar to our subprime markets from a few years ago. Could China also suffer a banking crisis like the U.S. did in 2008?  What if the European fiscal problems flare up yet again?  There is also risk of a Japanese debt crisis which would disrupt the second largest bond market in the world.  Japan has a new government which has, in effect, eliminated their Central Bank independence. With a debt to GDP of over 250%, zero percent interest rates, and a large fiscal deficit; you have a high octane and tenuous situation in Japan. Lastly, the U.S. fiscal cliff debt ceiling showdown could end up being a disaster if you have an intransigent Congress that is unable to reach a compromise.

Investment Strategy in this scenario:

• – Very wide range of returns for stocks and risk assets, but negatively skewed:  -5% to -30%
• – Dollar would be sharply higher by 10% to 30%
• – Strong argument for holding large a dollar cash position
• – Gold would provide a safe haven and do well

At present, the recent momentum and observations indicate that our baseline scenario is most likely. We intend to continue positioning portfolios respectively, and in accordance to your individual situations. We will remain nimble and alert in case some of the alternative scenarios become more of a reality. In all, we are excited about the New Year and the opportunities that lie ahead. Thank you for entrusting us with your wealth.

The Vigilare Wealth Management Team