Sound and Fury

(Excerpts from this week’s Stock World Weekly)

“Life’s but a walking shadow, a poor player, That struts and frets his hour upon the stage, And then is heard no more. It is a tale, Told by an idiot, full of sound and fury, Signifying nothing.” (Macbeth, Act 5, Scene 5, lines 17-28) 

Shakespeare’s famous quote wasn’t written about the stock market in the year 2011, but it could have been. Hardly reflecting the tensions in the global economy, and volatility in the financial markets, the S&P 500 ended the year virtually unchanged. But the markets were far from dull and lifeless. Without the help of the Federal Reserve’s free money handouts to the Primary Dealers (in the form of Quantitative Easing and later, Operation Twist), and promises to hold interest rates down through 2012, we suspect the stock market would have better reflected the world’s conflicts and the crises du jour.

The Dow and Nasdaq registered a little more life than the S&P, with the Dow up 5.3% and the Nasdaq down 1.8%. It was a traders’ market. Playing the ranges, shorting overpriced stocks, hedging effectively, and knowing when to run, were winning strategies for surviving the sound and fury.

As Joshua M. Brown, The Reformed Broker, wrote, “So much screaming and yelling and blogging and digging and questioning and panicking and crying and fighting and analyzing and hand-wringing and soiled diapers – and at the end, the S&P 500 closes down less than 5 tenths of a percent, de facto break-even on the year. Listen closely – the Gods are mocking us; the very heavens and firmament shake with their bellicose laughter….

A portfolio loaded with defensive stocks and Treasuries would’ve crushed the market. Conversely, a portfolio loaded with Netflix, Green Mountain Coffee, Sina, Baidu, silver, palladium and all the other “can’t miss” garbage would’ve impaled you like a Transylvanian dissident. And the more you “traded the news” this year, the more your portfolio came out of it looking like ground hamburger meat, let’s keep it real.” (The Most Hilarious Year-End S&P 500 Finish in Market History)

Phil discussed his predictions for 2011, noting his “It’s Never too Early to Predict the Future” article from December 19, 2010. In that article, he wrote “Obviously, I am fairly convinced that Global ‘leaders’ are making all sorts of policy mistakes handling the economy and I believe it will all end in disaster but that does NOT mean I am market bearish.  

“Think of it this way: If you come across a fire that is consuming a house from the inside and the firemen show up and spray water on the outside, then I will stand there and tell you that the house will still burn to the ground. However – I will also tell you that the house is going to be soaked in water. The two things are not mutually exclusive – just as a slow-moving economic collapse and a booming stock market are not mutually exclusive – especially if that collapse is the result of a transfer of wealth from the working class to the investing class (see the 1920s).”

While the global economy suffered severe financial and social repercussions of the global financial meltdown, the U.S. stock market managed muddle through the year largely unscathed, with the Dow making modest gains, the S&P going nowhere and the Nasdaq ending slightly lower.

YTD-tableThe rest of the world didn’t fare quite as well. As the New York Times reported “Despite the bruising it took in 2011, Wall Street managed to score one of the better global performances. Major European and Asian indexes lost anywhere from 6 percent (Britain) to 26 percent (Italy) for 2011… Some analysts said investors would most likely be better braced to handle policy changes in the nations that use the euro. ‘Investor reaction should continue to get better,” said Jack A. Ablin, chief investment officer of Harris Private Bank. ‘For as lousy as Europe’s news is, it has got to be the slowest moving train wreck in the history of the financial world. It’s the stuff that comes over the transom that kills us.’” (American Stock Markets End 2011 Where They Started)

The table to the right is by Doug Short, who summarized: “The final tallies illustrate that, although the eurozone financial crisis has garnered all the attention in recent months, the Asia-Pacific was home to the year’s biggest losers. The SENSEX had the worst year, with a loss of nearly 25%. But the Shanghai Composite has fallen furthest from its interim high (see the inset in the line chart below). It is down a whopping 36.64% from its 2009 high, with the Nikkei, Hang Seng and SENSEX in a near dead heat for next to last, posting declines in the 25%-26% area.” (World Markets Year-End Review: Good Riddance to 2011!)

Discussing China and the new year, Phil wrote, “Another big question for 2012 is ‘Will China avoid a hard landing?’ I’m a little more concerned that the real question should be ‘Does the Emperor actually have ANY clothes at all?’ We’ve already seen how well avoiding the hard landing went for the US and Europe – despite our ‘leaders’ and ‘top economists’ assuring us they could soft-land this puppy. Now the 787/A380 that is China is coming in for a landing and by all accounts, it’s a very short runway.”

One country to watch for signs of problems in China is Australia. Australia is China’s biggest trading partner and a primary supplier of raw materials to Chinese factories. The Wall Street Journal reported, “(Chinese) demand is powering a mining and investment boom Down Under that’s accounting for roughly 14% of gross domestic product and the lion’s share of growth. The Reserve Bank of Australia says that mining-related capital spending grew by more than 50% this year. But dependence on Beijing’s demand for resources, which accounted for most of the 64 billion Australian dollars (US $66 billion) of total exports to China in the 2011 fiscal year, makes Australia vulnerable.” (Australia Risks China Hard Landing)

According to the Financial Post, “China’s economic growth has slowed down for three consecutive quarters and economists widely expect full-year growth in 2012 to be below 9% for the first time since 2001 as business feels the impact of weakening demand from American buyers and Europe’s festering debt crisis… Evidence has grown that the real economy — especially private businesses that create most new jobs — is being starved of affordable credit. Those concerns in part triggered a net outflow of capital from China in October — the first such outflows in four years — when worries about the global economy prompted some investors to withdraw speculative funds.” (Risk of China hard landing rising)

Between the “Black Debt” plaguing the eurozone, the social upheaval in the Middle East and North Africa, troubles in Japan, a probable  “hard landing” in China, and the continuing malaise in the U.S. economy, it is difficult to make an optimistic case for the economy in 2012. If the stock market actually reflected economic conditions in the real world, there would be little reason to be bullish. However, the stock market is subject to a variety of manipulations, and the biggest manipulation of all is intervention by the Federal Reserve.

To quote Jesse’s Cafe Americain: “Tell me what the Fed and ECB will do and I will tell you how stocks will perform. That is the nature of this market.  The pricing of stocks remains largely inefficient, and often with a fraudulent intent.” (The Most Significant Developments of 2011 with Trends in 2012)

When the Fed initiates programs such as quantitative easing, designed to give free money to the Primary Dealers to prop up the stock market, the stock market responds, at least for a while. (Arguably its response grows weaker with continued interventions – much as a drug addict becomes tolerant to his drug of choice.) With the Fed’s unofficial “third mandate” to keep stock prices higher, we believe the Fed may intervene again, print more money, send the Dollar lower, and launch commodities and stock prices higher. Sadly, that scenario is the basis of our most bullish premise – events that are so destructive to the economy that the Fed may take action and turn the tide in favor of the bulls.

Phil gave us three bearish “disaster hedges” – ideas he shared with Phil’s Stock World Members on Wednesday… We also have a new trade idea and several repeated ones this week from Pharmboy. (To read more details on the option trade ideas, sign up for a free trialPharmboy’s updated ideas and an explanation of his favorite strategy – buy/writes – are here.)

2012 promises to be eventful. We are looking ahead to another Presidential election in a highly charged political environment. In the social arena, we expect worldwide outbreaks of violence, and massive protests, including more from the “Occupy Wall Street” movement after the weather gets warmer. We expect the global economy to be tepid at best, and ridden with crisis after crisis at worst. We anticipate more unemployment in the West, and a slowing export market in the East. While we’re not bubbling over with optimism, we believe the New Year will be anything but boring.

HAPPY NEW YEAR!