Following the post I wrote regarding equities (Article: Possibility Of A Correction Approaching) on Wednesday, I received quite a few emails that were questioning my bullish outlook despite writing about a sell off. I also noticed some forums and blogs used the article as a proof that a bearish outcome in stocks is about to occur, where the Dow Jones will fall "below 10,000" in the next few months of 2012. I want to make it clear that this is definitely not my view, as all I am looking for is a pullback correction and not a major sell off. These are some of the reasons I am bullish on mainly Commodities but slightly on Equities as well, while being bearish on Government bonds and US Dollar in 2012:
1. Credit Pressure Easing
I thought it is appropriate to explain the situation a little bit better, but this time around focusing on the credit and bond markets as well as equities. Printing money does not solve problems. But it does postpone them, however. And that is precisely what the ECB has managed to achieve with its recent liquidity injection late last year through a process known as LTRO. Furthermore, let us not forget the reopening of the Swap Lines by 5 major Central Banks around the world. With Central Bank balance sheet increasing in last few months (printing of money), what has been the outcome?
Credit market pressure I have been tracking and discussing over the last few months in several posts, is now starting to ease. This is a positive outcome without a doubt. First of all, Euro Dollar 3 month swaps are starting to come in from -150 basis points all the way to -80 basis points last night. That means Dollar funding is starting to ease. Second of all, Financials Sector CDS index is topping out as the fear slowly clams. Furthermore, Euro Libor OIS readings are now starting to reverse too, which means bank trust is slowly reversing from a possible lending freeze outcome. All of these signals will most likely also push banks towards putting cash to work, instead of pilling into ECB overnight lending facility. We possibly could have already seen that last night in Europe, with successful Spanish Bond auction.
On top of that, 2 Yr Yields from Ireland, Portugal, Italy and Spain are all falling dramatically. Chart above shows that bank funding problems in the US are also falling dramatically too, according to the 2 Yr Currency Swaps. That means that the ECB has managed to create a safety net for the time being, giving one last and final chance to politicians and bureaucrats when it comes to Eurozone Debt solution.
Therefore, my view is that while Feds/ECBs balance sheet expansion (money printing) through Swap Lines & LTRO is for the purpose of buying time only, it will last for awhile and maybe into 2013. So with that in mind, my whole point is that we have another Risk On rally for at least the next 6 to 9 months. On of the first positive signals is that banking and other financial stocks are now starting to outperform the S&P 500. As you might remember from my previous posts, that is one of the surprises I see occurring in 2012.
2. Investors Are Negative On Risk
Retail investors shown by mutual fund flows in chart above, are selling stocks at the fastest pace since middle 2002 and late 2008 - both of which marked major bottoms. What a horrible mistake this will turn out to be for the next several quarters or so. Add to that hedge funds having had an awful year, losing between 4% to 8% on average in 2011. That should make us all think that these managers will be chasing some performance in 2012, as their net long exposure is now as low as early 2009.
Underinvestment due to fear, with high levels of cash which does not yield anything, seems to be the name of the game for most fund managers. Merrill Lynch Survey is showing exactly that, with managers holding large cash levels indicating lots of fire power on the sidelines to push risk assets higher.
3. Strategists Are Bearish
The consensus view, according to Bloomberg terminal data, on growth is along the lines of a weak first half of 2012 and a recovery in the second half. I disagree. My opinion, which I have held since maybe late November and December 2011 (as I started deploying cash in my portfolio), is that we will get a stronger than expected first half in pro risk assets as well as growth (minus Europe).
Lets rewind back to early 2011 when Wall Street strategists were forecasting a very very bullish rally for the year. What we got was a volatile year that pretty much shed of at least 20% from the S&P 500 peak by early October. Fast forward to early 2012, and these same "gurus" are now expecting one of the smallest ever gains for the year - in other words they are bearish. S&P 500 target mean by Wall Street is now 1,363 - which means a 5% rally from here. With strategists doing a 180 degree flip from 2011, so should we.
Bill Gross, on the other hand, who was bearish on Treasury Bonds in February 2011 at the bottom, has now increased his exposure towards 30% of his fund. After super fearful 2011, where majority of investors flocked to Governments Bonds around the world, rather than be bearish on stocks, I have a feeling that it will be much wiser to be bearish on Government bonds in 2012. That is where all the investors are sitting now due to fear and that is the most overcrowded trade. Just watch the get flushed out towards pro-risk assets in coming months...
Summary: Everyone Expecting Euro Disaster In 2012
So with all that in mind, do you really want to buy high and sell low? Expecting Euro Crisis to explode in 2012 and stocks to plunge hard from these levels is very much a consensus view. The first part written on Wednesday is to help time the markets in a better fashion and not chase the upside move for now. It was not written as a gloom and doom post to let you know equities will tank from here. So in other words - yes, I am looking for a correction in equities, but I am saying that it will be a buying opportunity as the year surprises to the upside, not the downside.