2012: Glimmers of Hope

Traditionally, at the start of each year, Our Man looks at some of the major things that could help or hinder the economy and markets during the upcoming year.  As such, here are this years Glimmers of Hope (see here for an explanation of the thinking behind Fingers of Instability and Glimmers of Hope), which looks at some of the things that could go right in the economy and drive markets higher.

- Monetary Policy and (lack of) Inflation

The largest stimulant to the market in 2012 is once more likely to be the action of central banks and their policies.  Perhaps, I’m just cynical, but it seems to me that the Federal Reserve (since the Greenspan days) is late to every issue and believes that they can all be solved through injecting liquidity.  As such, we’ve seen rates cut (to 0%), promises to keep them there for years, Large Scale Asset Purchases (aka Quantitative Easing 1, 2, Lite, etc) and even recent coordinated central bank actions to help provide liquidity.  With the make-up of the Federal Reserve’s Open Market Committee changing in 2012 to likely become yet more dovish, I’m fully expecting more of the same in 2012; promises to hold rates lower for longer, more asset purchases (QE3…) and probably some new fangled way to try and force longer-term interest rates to stay low (maybe they’re even reckless enough to sell options).  The ‘good’ news is we can probably expect monetary easing from everywhere else of note in the world!  The ECB is already lending to European banks at generous rates (1% p.a. for 3yrs), the Japanese were the first big users of QE, and the Chinese are likely to loosen policy in an attempt to stave off a hard-landing for their economy.  In short; the Central Bankers of the world agree – sell your bonds, and buy risky assets…please!  This plea and its impact on market participants psychology is what most worries Our Man, given his bearishness.

- ‘Constructive’ Government behavior (i.e. can-kicking)

In the US, while the two parties have shown no ability to solve any major problems by working together and with both parties having more incentive to disagree (it’s an election year, after all), it would seem like the possibility for constructive government behaviour is limited.  However, the government behaviour I’m expecting is not the “solving of problems” kind but the “let’s give things a bit of a sugar-high, so the economy is still weak (and thus Obama can lose) but not so bad that we don’t all get kicked out of office (so incumbent Republican congressman can keep their seats)” kind.  This is the type of compromise that leads to terrible long-term decisions, with faux compromises on a small short-term stimulus which will be paid for by some future (probably unspecified) cost cuts.   While these types of deals are not good for the long-term health of the economy, they can help stabilize things in the short-term and also support the equity markets.

In Europe, Our Man expects much more talk of Grand Plans, bazookas, and anything else that can keep sentiment up while only a limited amount of new money is provided (via the EMU countries, or IMF) to deal with budget issues and stave off defaults, Central Banks attempt to provide liquidity, and elected governments are replaced by IMF/EU-approved “technocratic” ones.

In China, with the economy slowing the government will no doubt do its best to try and reignite the credit-fueled boom, be it through encouraging banks to lend (directly or indirectly, through reducing reserve requirements) or other measures.

- Housing Market

It may have taken a while, but the moribund state of the housing market is acknowledged as a major issue problem by both the Administration and the Federal Reserve.  The importance of the issue can be seen in the constant rumors of an Administration plan on housing, as well as a recent speech by William Dudley (President of the NY Fed), which even offered his thoughts on potential solutions.  While there merit and effectiveness of the proposals can certainly be debated, it’s a step in the right direction.  Efforts to help reduce the problems in the housing market, if effective and well-thought out, would unquestionably help both socially and economically.

- Falling Unemployment (and rising incomes)

While there’s many flaws in the data (and its computation), it’s also clear that jobs data in the US is consistently improving, albeit at a slower pace than everyone (I think) would like.   Now perhaps this improvement slows or reverses later in the year and there are seasonal biases benefiting the data currently, but the declining trend in unemployment, positive revisions and increase in hours worked (which will, hopefully, feed through into incomes) is unquestionably good for the economy!  With companies being in a relatively strong position, if demand continues to hold up well, there is potential for this favourable trend to continue.

- China & an Asian soft landing

What if Our Man is wrong?  Just because nobody else has succeeded in controlling their economy, or transitioned from an investment-driven one to a consumer-driven one without going through major pains, it doesn’t mean that the Chinese won’t.  Perhaps they’ve just built a better mouse-trap for managing the economy than the rest of us…

- Valuation
This is a repeat from prior years’ lists..  Our Man continues to mutter that it’s an expensive market (and using longer-term measures it is) but if one only looks at short-term horizons (or uses current year P/E, or mutations of it…such as P/E based on Operating Earnings, or projected forward P/E, etc) then an argument can be made that the market is cheap.