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November 2012 Investment Journal 


The U.S. stock market declined early in November, then rallied to close the month with just a slight loss. International equity markets, both developed and emerging, fared better than the U.S. Bonds posted positive results across the board, continuing to show little volatility as Bernanke and the Fed keep interest rates ultra-low. Finally, commodities made a comeback this month after a negative performance in the previous two months:
US elections took center stage early in the month, and the markets gave a good Bronx Cheer to accompany the results. Both parties more or less kept their balance of power, but in this case, gridlock was not good: the S&P 500 declined 5% within two weeks of Obama's victory before recovering over the balance of the month.
After a brief pause, markets quickly turned their attention to the "fiscal cliff". There is no way to handicap the outcome, but Erskine Bowles, a savvy former DC insider, has publicly stated that there is only a 1 in 3 chance that a compromise will be worked out before year end. Speaking in Chicago this month at Charles Schwab's annual IMPACT event for independent advisors, which we attended, he gave the audience an earful with side-kick Alan Simpson. They predicted a very unwelcome market reaction to a "nothing done", and it makes sense to prepare for a very bumpy period ahead.
We also heard recently from Bob Adams, McGladrey LLP's national Tax Partner at their recent Greensboro NC "Alumni & Friends" event. His view was that a "patchwork" deal would eventually get done, albeit perhaps not until early 2013. The real changes will be coming later in 2013, after the new Congress is sworn in. A more comprehensive solution, especially with respect to simplifying the tax code as called for by the Simpson Bowles Commission, was a real possibility. Thus, any "cliff-hanger" solution, in his book, would be temporary. The question for investors is "can we get there without any collateral damage"?
The US economy continues to drift down from recent peaks. Investors are mindful of slowing earnings momentum, and now there is a clear pattern developing in New Capital Goods Orders, which declined 8% year over year at the latest reading. This component of Durable Goods Orders is considered one of the least susceptible to manipulation of all the leading indicators, and it is clearly breaking down:
There has never been such a steep drop in the past 30 years without a concurrent recession, so we'll see if the dreaded "R" word starts to appear more often in the media and investment commentary world.
In Europe, the big news this month was an agreement on the (third) re-structuring of Greek debt, which Germany begrudgingly approved (it appears they are now "all in" on the Euro experiment - no "Grexit" for now).
Terms of the complicated agreement call for the existing European rescue fund (EFSF) to first provide money for Greece to buy back its own debt from banks and private investors at a steep discount (roughly 34 cents on the dollar - European member states get to "eat" the other 66 cents). Then, once that debt gets wiped out, international creditors (IMF, etc.) will be OK with advancing the next tranche of "aid". In other words, after losing 66% percent of their principal (after the first round of loans lost around 75%), they're going to tee up another round, but this time with lower interest rates and longer maturities so Greece has time to "recover". Third time's a charm? Probably not.
Meantime, flying underneath the radar, Swiss megabank Credit Suisse announced this month that they would start charging customers to hold cash balances in Swiss francs, advising depositors to "keep cash balances as low as possible to avoid negative credit charges". They are daring anyone seeking safety to find a home in Switzerland. (Remember that Swiss accounts are host to a vast portion of international wealth, including Asian and Middle Eastern customers, so this will affect a lot of very serious investors. US "persons", thanks to relentless attacks on centuries old Swiss banking secrecy laws by the IRS and US Treasury, have been "evicted" from the Alps, and are not welcome.)
Since the Swiss National Bank has fixed their exchange rate at 1.20 francs per euro, they can't print francs fast enough to defend the peg, so now their largest private bank is helping out. The world of NIRP (negative interest rate policy) is alive and well in Switzerland, and it looks like the "currency wars" are now morphing into outright capital controls.
Not coincidentally, at month end the International Monetary Fund (IMF) endorsed a major shift in its ideology by supporting the use of direct controls (i.e. taxes and regulations) to calm volatile cross-border capital flows, a technique usually reserved for younger emerging economies. While urging the use of traditional macroeconomic responses to rapid inflows of currency (like lowering interest rates), the IMF flip-flopped on its long held view that liberal cross border flows were a good thing. This is a real game changer, and it sets the stage for more restrictions on the global movement of capital down the road, which will very definitely have the capacity to influence investment markets. The whole paper can be read here:
As markets head into year end, investors will be busy trying to position for new themes and strategies. In the US, tax driven selling may increase this year due to increases in capital gains and dividend tax rates in 2013, which could present some compelling buys. Brinksmanship in Washington will likely keep markets on edge throughout the month, again presenting some possible buying opportunities. Interest rates remain ultra-low, and the wave of Boomers retiring is just beginning, so the search for income will be ongoing and paramount. That's an investment theme that has a long way to run.
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