Below is the full 2012 Bespoke Roundtable Q&A with Jeff Pietsch of ETF Prophet.
None of my Roundtable comments should be construed as individual investment advice. Please consult with your advisor about developing a plan that is particular to your personal circumstances and risk proclivities
1) Looking back on 2011, what were your best and worst calls?
The two market calls I was most pleased with were: first, identifying a safety-switch from equities to bonds in mid-July; and second, calling a rare "black swan event" in very early August. The first was based on a relative strength versus volatility signal featured in ETF Rewind Pro, the second was based on the behavioral premise that investors would be quick to sell and slow to "catch the falling knife" after two major bear events in less than ten-years' time. In addition, decade-old short-term reversion tendencies had been diminishing since late 2010 and volume had been running thin, and, here we are.
My worst personal trade was attempting to fade that very same market call literally a day too early: the Friday before the U.S. Debt downgrade. Do you remember that very long weekend? It is water under the bridge now, but I certainly do.
2) What surprised you the most about financial markets in 2011?
As primarily a quantitative trader, I am rarely surprised in the sense that I hold few long-term preconceptions or fundamental theses per se. So, in fact, this idea of an annual outlook is a bit of an anathema to me, but a fun and valuable one nevertheless!
From a price action perspective, there were indeed several sizable surprises:
- The relentless efficiency of the upward march from late-2010 through the Spring of 2011. The lack of choppiness and short-term reversion was a true about face from long-standing price tendencies.
- The magnitude and speed of the late-July/ early-August downdraft. By some measures, nothing like it had been seen in forty years, and it caught many market timers off their guard.
- The strong technical reaction on October 4th, quite literally right off "official" correction lows of -20% peak-to-trough on the S&P 500. It still seems awfully convenient!
Add the last two surprises together with the withdrawal of Quantitative Easing from the first half to the ongoing negative news flow, and I am quite surprised that the major U.S. indices are not down further on the year, not to mention that fact that the VIX has so quickly found its way back to the mid-twenty range.
Indeed, the year has held up surprisingly well given all the potential shocks across the globe, and the U.S. has even shown some signs of decoupling from the global malaise.
3) The S&P 500 hit its bull market highs in April 2011. Which will happen first? Will we first take out the April highs or have we entered a new bear market (a decline of 20% from the highs)?
Non-dividend adjusted, the S&P 500 has already made a 20% intra-day decline off those highs, so there is a certain answer. Looking ahead, at this moment in time and perhaps against expectation, equities are looking relatively strong near the mid-point of that range. Save a strong decoupling from Europe; however, on balance I would still look for a retest of those lows before new highs.
4) Depending on your answer to question 3, how long do you expect the bull or bear to last?
I expect this current "volatility" bear to run well into 2012 according to on-going news flow and past bear markets, which have typically lasted 12 to 18 months in duration.
5) How should an investor with average risk tolerance be positioned for the year ahead?
Consider holding stocks, intermediate-term bonds and commodities equally with a significant overweight to cash (let's say roughly 20%) until more technical green lights are offered and an investing theme has more clearly expressed itself. For now I see no reason to play the wide-ranging volatility unless you are an accomplished day-trader.
6) How do you see the European sovereign debt crisis playing out in 2012?
I believe that the Europeans will eventually come to realize that debt-monetization is the only solution to their collective problem. An interesting alternative to completely dissolving the Euro would be to maintain all cross-commerce aspects of the Euro-zone treaties, but otherwise split the currency according to credit risk profile.
7) How bullish or bearish are you on the following markets: The US, Europe, Developed Asia, China, Emerging Markets?
Relatively speaking I am neutral to moderately bullish on the U.S., continue to be bearish on Europe (although this increasingly appears to be "priced in," if there is such a thing), neutral to slightly bullish on Japan and China, and moderately bullish on Emerging Markets. However, all the bullish outlooks are going to require a certain level of decoupling, so risk is clearly high. Can the U.S. in-fact lead the world out its current slump? I do not think the answer will be long in coming.
8) What do you believe is the contrarian call on equities right now?
The contrarian call would be a near-term start to a new multi-year bull market. There are those who will make that contrarian call solely on principle (they like to swim against the stream just because). I am not one of those, however, first requiring evidence to that end. Certainly a comprehensive resolution out of Europe could be the catalyst for such a reversal. If that does happen, look for the sectors that have been most beaten down to lead, prospectively including the Financials.
9) How confident are you that US companies can live up to current consensus earnings expectations?
Based on the acceleration of recent downward guidance and the unusually high level of economic risk scenarios for the New Year, my confidence is relatively low. Rapid cost cutting has supported earnings thus far, moving forward sales will have to keep pace.
10) Are US stocks cheap right now based on the valuation methods you rely on most? Will multiples expand or contract in 2012?
Historically speaking, stocks are extremely "cheap" on a trailing Price/ Earnings basis. Indeed, the relationship is at levels not seen since the late 1980s. However, that multiplier obviously reflects a strong risk premium, and I do not think anyone can say that is not justified in combination with relatively low forward growth prospects. The good news is that if we do see any sign of either news flow recovery or global earnings stability, there could be significant multiplier expansion at any point ahead.
11) Describe some of your favorite market indicators and what they are signaling for stocks in 2012?
Relative Strength readings as a measure of risk acceptance are currently signaling extreme caution for early part of the year. However, Intermarket readings are nearing a potential inflection point where that could shift back to more of a risk-on reading. The next few weeks will therefore be especially technically important.
12) What are your favorite and least favorite sectors for the year ahead?
Going into 2012, I will likely continue to prefer the safety sectors, including: Utilities, Consumer Staples, and Healthcare, with some Real Estate for good measure. Conversely, for now I will probably continue to stay away from the Financials, Telecom, Materials and Industrials.
13) What is your outlook for Financials?
I am looking for continued weakness in Financials for the time being. However, from a price standpoint, they have been so badly beaten down in 2011; they could easily lead any 2012 turnaround on the right news flow. That is not a prediction, so much as a strong possibility to be aware of for those pressing the short side.
14) What is in store for the US economy in 2012?
More than ever, extreme scenarios that used to be laughed at or otherwise considered tabled for the future evaluation now look like actual possibilities, even if remote. I see pricing economic risk for 2012 as an exercise in real options analysis. On one path we have Europe "blowing up" and taking interconnected global markets down with them. On a middle road there are continued overseas disruptions, but a U.S. decoupling. Finally, there is the path of global stabilization and resumption of moderate, albeit slow growth.
Whatever probabilities one assigns to these scenarios, the particularly dramatic spread of alternatives suggests the possibility of a volatile year ahead. For now, improving U.S. economic reports and relative outperformance in equities supports the middle road, but investors literally need to be prepared for anything ahead.
15) Economic indicators as a whole came in better than expected in the fourth quarter. Do you expect this trend to continue in the first part of 2012?
Yes, I expect this to continue, and, by many measures, the U.S. appears to be decoupling. I do wish I had better confidence in standard economic reporting. Either way, risk obviously remains high and further strengthening of the Dollar could also serve to moderate this success.
16) What is your take on the employment picture in the US? Will we see the unemployment rate get below 8% by Election Day?
I am mildly positive on the employment picture and do believe it is possible to break below the 8% mark; how much lower is the real question, as "structural unemployment" is likely higher than the historical 5-6% range taught in Econ-101.
Although this statistic likely grossly understates true unemployment, a number of factors could contribute to this outcome:
- Many unemployed have effectively given up the search, taking them off the official roles. Ironically, any economic rebound could initially see resurgence in workforce participation, so a sustained recovery will be required to absorb this supply.
- Using alternative measures, significant labor productivity gains from the last twenty years have flattened. Also, large corporations have become highly efficient at managing workforce size. Together, the nation's service orientation should thus require added labor units to meet any on the margin increases in economic demand.
- Politicians will be motivated to eventually roll forward the payroll tax deductions and other incentives into elections.
Lastly, the current rate of decline has been -0.1 point reduction each month. A steady state/ half-as-good improvement over the next year would bring us well under 8% on this basis alone.
17) Are Ben Bernanke and the Fed helping or hurting the recovery?
There are many aspects to this question. First, it is clear that Fed actions averted a potential catastrophe in 2009. Second, positive correlations have been shown between Quantitative Easing and the major stock market indices. So from 2009 to mid-2011, we can also say that the Fed helped to support a balance sheet recovery. What is less clear is the degree to which these effects were lessened by deleveraging, cross-border leakage, and other factors exogenous to U.S. dynamics. Going forward, how they may ultimately lead to inflation/reduced buying-power remains a concern.
Another measure of recovery is the stability of the post-event market structure. To the extent the Fed has aided in internalizing individual company risk, allowing weak companies to continue to survive, this arguably reduces the viability of the other survivors.
Lastly, the Fed has adopted a new transparency policy. A question to consider is whether providing economic outlooks in a down economy is not self-defeating given its institutional influence- if the Fed broadcasts weak growth forecasts, does that outlook not become self-fulfilling?
18) The Fed's Zero Interest Rate Policy (ZIRP) has really hurt savers and anyone out there looking for yield. Where should investors go to find yield right now?
Investors may consider seeking yield among low volatility dividend leaders (see Question 31). In addition, dividend capture strategies, diversified intermediate duration corporate bond flights, and select options income strategies may also be appropriate.
19) The housing market continues to struggle. Are we close to making another bottom in residential real estate? Are there specific areas of the country that you are more bullish or bearish on?
National sales figures over the last several years were recently downwardly revised based on double counting problems, so fresh bottom indeed! Also, while the rate of decline in pricing has slowed, it has hardly reversed. Prices could drop another 5-10% before having reverted to their pre-parabolic trend. Projecting forward, I think it is reasonable to assume that could occur within the next one to two years.
U.S. Census Bureau projections suggest that the South Atlantic, Pacific and West South Central regions will experience the highest population growth through 2030. I would use those net migration/growth estimates to guide my macro view. Longer-term, downsizing by the aging baby-boom generation presents a sticky demographic problem that goes far beyond the current easy-money bubble correction.
20) Will the Dollar (US Dollar Index) be up or down in 2012 and why? Are there any other currencies that you have a strong opinion on? How much trouble is the Euro in?
The Euro is obviously in a good deal of trouble, but I will grant that it has already experienced a significant retrace. If there is a global recovery, the U.S. currently looks to lead. Assuming reserve rate increases would also be U.S. led, for now I assume the Dollar will continue to hold or advance well into 2012.
21) Gold has underperformed stocks in recent months. Will this continue in 2012? Will gold see gains in 2012?
The initial panic of the sovereign downgrades has moderated, and the inflation/QE trade is off the table here and abroad for the time being. Since I do not know how the problems overseas are solved without printing, however politically improbable that may seem just now, one way or the other I believe gold will eventually see gains in the year ahead.
22) The ratio of platinum to gold is currently at its lowest level ever (platinum is actually cheaper than gold right now). Is platinum a good buy relative to gold?
If we see a strong non-inflationary economic recovery, that could be an interesting long-platinum/short-gold pairing, but I suppose that is a pretty big if at the moment. With platinum down over 15% and gold up about as much in 2011 and near-term correlation on the rise, there may well be a technical reversion trade there on either side. However, with such different fundamental/behavioral drivers, I only see a marginal intermediate-term tradable relationship between the two. At this moment the technical case maybe a bit stronger for silver as the long-side in a pairing, but only for a trade.
23) Where is the price of oil headed? How about the spread between Brent Crude and West Texas?
On an intermediate time-frame, oil has been steadily stair-stepping higher since the 2009 lows. I would expect that gradual rise to continue into 2012 (see question 30). Based on my U.S. decoupling/recovery leadership hypothesis, I would further expect WTI to regain a portion of the spread it has recently given up to Brent on global outgrowth (relative demand) and North American pipeline development (supply). With respect to the pipeline issue, political outcomes in 2012 could play an obvious role, favoring the WTI on a Democratic win in either the Whitehouse or the Senate.
24) What are your predictions for the 2012 election? Which party will win the Presidency, the House and the Senate? Who will become the GOP nominee, and what are the chances that nominee will beat President Obama?
Right now it is difficult to see a sufficiently strong challenger to President Obama among the GOP candidates. On the margin, I expect Obama to win over Romney, the presumptive GOP nominee. By the same token, it is looking like the Republicans have a good chance of overtaking the Senate in addition to the House.
25) How will the elections impact the stock market in 2012 and beyond?
Markets typically hate uncertainty more than given outcomes per se. Historically, the first one to two years of a new presidency have been hardest on markets, with years three and four the most supportive, especially during re-election years such as we are headed into for 2012. Frankly, however, I don't give much weight to these tendencies and I believe macro-economic factors will ultimately dominate politics in the year ahead.
26) Will the US Supreme Court rule that ObamaCare is unconstitutional?
Putting my lawyer hat on and politics aside, I have to admit that I was not aware just how legally loaded the "Patient Protection and Affordable Care Act" case was until after researching the facts.
A half-century long-plus jurisprudential trend has been an increasingly broad and non-literal interpretation of the Commerce Clause. Conservatives would like this case to represent a strict line in the sand. Where it not so timely in light of the pending 2014 "Individual Mandate" section of the subject bill going into effect, it is easy to see how the bench would have normally preferred to take a pass on this case given the charged politics and electoral timing.
To summarize, recent precedent could easily be used to support the bill, and health care costs clearly have a large-scale impact on commerce. However, strict constructionists will see it as over the constitutional line, compelling purchase of a heretofore nonexistent product. (Query though, aren't I forced to buy services when I pay my taxes?) And, there is heavy state opposition to consider as well, overlaying Federalist concerns.
Therefore, individual member ideology could play a larger than usual role. In this regard, reviewing the court line up, I will conjecture two scenarios:
- Marginally Lower Probability: Justice Kagan (another matter altogether) makes a final hour recusal/ the decision is split and the lower court decision stands, voiding the bill.
- Marginally Higher Probability: Justice Kagan sits for trial/ on a near majority, the lower court decision is overturned, supporting the bill.
Either way, it is likely to be very close and highly watched. What I do know for certain is that my own family's monthly health care charge went up significantly after this bill passed, and that is not affordable by any twist of a too-clever-by-half congressional bill titling.
27) How do you see the US tackling its debt problems in the years ahead?
As I see it, growth will remain moderate, forcing government bodies to eventually find a political middle ground that allows for headline spending reductions and moderate tax increases that in fact will be nominal in scale. This is already occurring at the local levels. Means test overlays could help to further address the entitlements problem on a going-forward basis. That leaves the printing presses for historical debts, but perhaps we will all then feel better about the shared sacrifice that implies.
28) What are the biggest threats to the global financial system right now, and are they avoidable?
The largest threats continue to be the global interconnectedness of our financial systems and the increasingly high correlation among stocks and other asset classes. Neither is avoidable, but perhaps they can be mitigated.
In the best of times, global interconnectedness is a blessing, in the worst, a nightmare. Two approaches that may minimize risk are to:
- Place regional firewalls among banking and currency systems - a sort of hybrid between where we are today and where we were thirty years ago with countries sub-grouped by like credit risk and GDP outlook.
- Raising fractional reserve requirements as the Fed appears to be pursuing right now. Such a buffer will also have the impact of reducing the multiplier effect/systematic leverage (ironically offsetting any monetary pumping).
Both of these approaches in turn risk varying forms of political polarization. The first is potentially a step backwards from the geopolitical stability offered by economic interdependence, the second risks citizenry unrest with current lifestyle expectations no longer as widely achievable (think "occupy").
The correlation problem, on the other hand, relates as much to the emergent "risk-on, risk-off" mentality as the new class-based trading vehicles and mass adoption of algorithmic trading. I do not fault these trends in their own right, but their real combined implication is higher volatility/ daily value-at-risk (think "flash crash").
As a secondary effect proven by negative fund flows in 2011, investor confidence is also at risk, further reducing volume and reinforcing this same volatility. Smarter, more active management of volatility at the exchange level seems the best approach to me here as opposed to broad brush, potentially stifling, if politically appealing transaction taxes and no-short rules.
29) Hedge funds as a whole underperformed the S&P 500 in 2011. How will hedge funds perform in 2012? What is your take on the hedge fund model in general?
Survival bias heavily influences the positive view of hedge funds, in fact, after fees they have tended to underperform as a class. Although I still like the concept of manufacturing diversification and certain shops do serially outperform, in general I do not think the model works well for investors under the 2/20 format, and I would prefer a carry on excess returns over a fixed or relative benchmark model.
30) Will the following be up or down (positive or negative) in 2012? Where noted, what are your 2012 year-end price targets? The price targets are meant to obtain a wisdom of crowds consensus number from all Roundtable participants.
-S&P 500 (up or down and year-end price target) Up, 1,350 point estimate against a wide 1,100 to 1,450 12/31/12 range
-Long-Term US Treasuries (up or down) Flat to lower, and with growing risk
-Corporate Bonds (up or down)
-Junk Bonds (up or down)
-Gold (up or down and year-end price target) Up, $1,800
-Oil (up or down and year-end price target) Up, $115-$130
-Dollar (up or down) Up
-Average US Home Prices (up or down) Flat to up
-China's stock market (up or down) Up
31) Please provide readers with any stocks that you really like right now for 2012 and beyond.
I am not a big proponent of individual stocks, except as trades. Nevertheless, here are twenty interesting candidates for longer-term core holdings based on a combination of technical and fundamental factors that I track, including low volatility, momentum, and a strong dividend history:
ABT/ ADP/ AMGN/ CB/ CL/ ED/ FISV/ GPC/ HCP/ JNJ/ KMB/ KO/ LLTC/ MAT/ MSFT/ ORLY/ PEP/ PAYX/ PG/ WMT
32) Where is Apple headed as both a company and a stock? How about Google?
I still like AAPL technically and its strong beachhead leads combining design, software and hardware integration appear difficult to breach. Together with a deep management bench, I see no reason why it should lose its status as the premium garnering consumer products leader.
GOOG is a tougher nut. Technically it appears to have found longer-term support and is an obvious powerhouse, but I continue to be amazed by how poorly-integrated and of mixed quality their non-search products are. Recently they seem to be addressing this, but I will take a pass until they show they can execute in a more cohesive strategic fashion
33) Facebook is expected to IPO in 2012. Would you be a buyer or seller of the stock at its opening price on the day it goes public? How long would you hold it?
Recent social-networking IPOs have largely been a short-term fade. Facebook has obvious scale and sticky usership, but they currently feature highly-concentrated revenue sources, and competition from the likes of Google is on the rise. I would therefore prefer to see a how they execute on their monetization and source diversification plans either post-IPO, or post-forced SEC filings before forming a longer-term hold opinion
34) Which technologies are you currently the most bullish or bearish on? Are any of them game changers like the PC or the Internet were?
I am highly interested in the various potential uses of graphene, Nano-scale manufacturing, and nascent quantum state processing technologies. As IBM's Watson versus Jeopardy project recently proved, massive processing capabilities overwhelms the shortcomings of our relatively poor ability to develop software. Bringing Watson-like capabilities to end-users through the aforementioned technologies in combination with the Cloud and wireless everywhere finally offers the prospect of widely distributed invisible computing, and that will be game changer indeed.
35) What are the website, magazines, newspapers, books, apps that you use the most and would recommend others to use?
Calculated Risk (http://www.calculatedriskblog.com)
Econompic Data (http://econompicdata.blogspot.com)
ETF Prophet (http://etfprophet.com/)
Financial Times (http://www.ft.com/home/us)
The Wall Street Journal (http://online.wsj.com)
Shadow Government Statistics (http://www.shadowstats.com)
The Drudge Report (http://drudgereport.com)
Reminiscences of a Stock Operator - Lefevre
The Daily Trading Coach - Steenbarger
36) What are your favorite Twitter feeds?
Condor Options (CondorOptions)
ETF Prophet (etfprophet)
Quantifiable Edges (qerob)
Market Tells (MarketTells)
Market Rewind (mrkt_rwnd)
Sentiment Trader (sentimenttrader)
Trading The Odds (TradingTheOdds)
The Woodshedder (Woodshedder)
VIX and More (VIXandMore)
Zero Hedge (zerohedge)
The Drudge Report (Drudge_Report)
The Onion (TheOnion)
37) Do you have any other advice that you would like to share with readers as we enter 2012?
Maintain a flexible view of the markets and use this time to reevaluate your investment strategy. Major behavioral shifts are afoot and traditional means of achieving portfolio diversification have been revealed as significantly flawed. Perceived risk is very high right now, but that could change on short notice and money has to flow somewhere. The last several years have offered this lesson in spades: there are times when it is beneficial to take on risk and others when it is not. You need a concrete approach to distinguish these periods or you will end up either very wrong, or left out of the game when it matters most. A Very Happy New Year to all!