Market Letter

January 12, 2012

Our investment approach to the Market is a combination of opportunity investing, macro considerations and outperforming companies with good branding and growth potential. Some have said it is a market of stocks rather than the stock market. We want to find those companies that will outperform, have potential take out candidacy or have been beaten down with good fundamentals. Our favorite approach is waiting for stocks to get hammered on bad news, nervous investors selling or falling out of favor during institutional sector rotations; then buy on the dip. This is primarily a secular bearish strategy. We are bullish when the conditions develop.

We chose to evaluate investing conditions in 2012 based on the current economic conditions and the upcoming 2013 and 2014 years. So this is a three year window.

2012

United States Political

This will be the year of the president. The general presidential election, House of Representatives and Senate will have market implications. If the market smells an Obama victory we expect a slow sell off throughout the year beginning in the summer or earlier. If however there is a voters’ change in the White House then the market could have moved up significantly by end of summer in anticipation. A voters’ change in president means a change in Federal Reserve chairman and ultimately policy. We could see interest rates inching up and less expansive of the Fed balance sheet.

A voters’ change in president would mean an Energy policy and less federal mandated regulations which would be bullish for the market in general.

Risks in United States Political Climate

The ongoing fiscal debt decision with budget cuts bringing less revenue to certain sectors within the market. An additional downgrade of US debt would be bearish possibly short term. A more hostile wrangling over increasing the debt limits could bring back volatility like last summer.

Other Risks

The Mayan calendar implications could affect consumer and business behavior.

Europe re-pricing its debt will affect yields and could widen risk within the European financial institutions.

United States centric spots of unrest or natural disasters.

Geopolitical Risks

Russia and Iran could bring instability. Major earthquake, storm or pestilence could disrupt supply channels. China could be more unstable than thought as centrally planned economy has its own pitfalls.

Potential Upside Potential

If China steps in and bails out Europe, the IMF imposes a broader gold backed monetary policy, the US gets its house in order, China and India eases monetary policy and any combination of these could cause swift upside early in the year. If the Iran tensions abate and growth is tepid we expect oil to pull back from the $105 range for WTI.

2013

This will be the year of Congress. In 2013 the Bush era tax cuts expire, the death tax has bigger bite and the surtax on incomes over 250K kicks in. These could push higher end luxury spending downward. Perhaps the most significant change would be the reduced expensing permitted business to deduct as depreciation and the disappearance of full expensing of assets as was the case in 2011. This has the potential to impact business investment and capital expenditure budgets so a downturn in gross domestic product could happen.

Europe could implement a gold-backed Euro.

2014

This will be the year of Diplomacy. In 2014 we will have the first full year of Obama Care and its effect on private sector earnings.

This is too far out to predict corporate earnings however four things could emerge:

Cash less system nearing implementation (with less currency brings higher tax receipts for governments)
Global territorial tax system world-wide with transaction taxes on investment, real estate and borrowing transactions.
More transaction taxes at state levels in the United States
Depending on who controls the White House we could see the emergence of a gold-backed trust fund to bring stability to markets as regard to rising levels of US debt.

Strategy for 2012

We would anticipate that this year will be a traders market once again. There are some potential longer term trends that will attract buyers namely agricultural, selected niche industrials and gold. In the coming year sectors in the technology space may have peaked as maturing companies. Growth may peak in some names. Unanticipated regulations could hit specific names. Where is the catalyst for the next phase of growth?

A run up here in the first quarter is entirely possible. Since each year the market corrects on average at least twice up to 10% one does not need to get caught in this correction. The most likely places for this to happen would be before second quarter earnings, end of summer and November through end of year. The end of year is plausible because of the expiring Bush tax cuts, a run up in the market for much of 2012, increasing interest rates for 2013, outcome of general presidential and congressional elections and with it changes in fed policy.

If we see a run up toward a 1360 number on the S&P this could provide some resistance without any clear catalyst in sight. There does not seem to be any compelling reason to be fully invested at these high levels but wait for pull backs and pounce in the lulls. If global growth recedes expect the slow trend back down to begin again and its bear territory all over with buy and hold almost impossible to predict with probability and charts.

Nonetheless there are always good emerging growth companies and industries that emerge as winners throughout any one year. What worked last year will not work this year and what works this year will not work next.

Note:

This is an editorial written to Horizon clients as part of our tax practice and economic advising toward healthy business practices.