Wednesday, January 4, 2012

This Year's Biggest Bet?

Ben Vickers of Bloomberg Business reports on This Year's Biggest Bet:

As economists and analysts attempt to summarize the outlook for the European crisis at the start of the new year, some will be making forecasts that time and their embarassment eventually will bury. Nonetheless, it is the perfect time to take a longer view than usual, free of the latest economic data point and the day-to-day market reactions.

Bill Blain, co-head of the Special Situations Group at Newedge Group, and Holger Schmieding, chief economist at Berenberg Bank, took a longer view on Bloomberg Television today. Alas, the solution to the euro crisis isn’t simple and it isn’t imminent, as Blain said:

The euro and markets crisis is not a binary issue—it’s not either default or solution. If there is a solution it’s not going to be a complete, miraculous the-euro-is-saved. It’s going to be something that continues to be a crisis for a long time.

Schmieding expected the euro crisis to worsen before a solution is put in place, but, in contrast to Blain, he said there will be a solution, maybe within five months:

We will have one wave of crisis after the other for a while. Initially, these waves will probably get worse, and then either market confidence turns, as it sometimes does— it often turns because so many people are so bearish there isn’t any extra mileage in being bearish. More possibly, the ECB will step up its response, and once the ECB does this, sentiment will turn and from then on the crisis will still come in waves, but they will receed in their level of danger.

So far the ECB has shied away from doing the one thing that could resolve the crisis once and for all: backstopping the bond markets of those countries that do all the things they have to do. That is, keeping solvent countries liquid, just as the Bank of England and the U.S. Fed are doing for their governments.

So, the discussion over the euro crisis does remains binary in one major sense: the world is divided between those who see a solution before 2013 and those who don’t. Schmieding said U.S. debt issues and not those of Europe will dominate the debate by the end of this year. Blain disagreed—Europe’s debt will still top the agenda at the start of 2013, he said. That has to be one of the major bets this year.

Once more, allow me to share with you what I think this year's biggest tail risk is: a melt-up in stocks and other risk assets. And the biggest economic surprise in the next 12 months will be the strength of the US economic recovery.

It was a great start to the new year as the ISM index handily beat expectations, rising to a six-month high, and stocks surged higher on signs of global growth:

Hoping for something better than 2011's flat stock market, U.S. investors pushed shares higher on Tuesday to begin the new year, though questions remain about whether a rally can be sustained.

The broad S&P 500 index closed at its highest since late October as traders, with cash on hand for the new year, welcomed better-than-expected German and Chinese economic data.

The upbeat response was reinforced by U.S. economic reports showing construction spending and factory activity beat economists' forecasts.

"There were some good economic numbers from outside the U.S., and people have cash to invest for the new year so that's driving up prices," said Giri Cherukuri, head trader at OakBrook Investments in Lisle, Illinois. "It's a good start but we'll have to wait and see for the trend."

Trading volume was below normal. About 7 billion shares changed hands on the New York Stock Exchange, the Nasdaq and Amex, compared with last year's daily average of about 7.84 billion shares.

Advancers led decliners on the New York Stock Exchange by more than 16 to 5 and by about 14 to 5 on the Nasdaq.

Materials companies and financials, the lagging sectors in 2011, were among Tuesday's market leaders with the KBW bank index up 3.3 percent. U.S. Steel (X) gained 6.5 percent to $28.17 after losing more than half its market value in 2011.

Strategists polled by Reuters in December expect the benchmark S&P 500 index to finish 2012 at 1,340 for a yearly gain of 6.6 percent. That compares with the S&P's mere 0.003 percent slip in 2011.

Data showed U.S. manufacturing sector growth accelerated in December at its strongest pace since June, while construction spending in November surged to the highest in nearly 18 months.

Some of the S&P 500's worst performers last year rallied on Tuesday. But at the same time, McDonald's Corp (MCD), the biggest gainer in 2011 among Dow components, fell 1.5 percent to $98.84.

First Solar (FSLR), down 74 percent in 2011, jumped 6 percent to $35.79 and Netflix (NFLX), off more than 60 percent last year, added 4.3 percent to $72.24.

The Dow Jones industrial average rose 179.82 points, or 1.47 percent, to 12,397.38. The S&P 500 Index added 19.46 points, or 1.55 percent, to 1,277.06. The Nasdaq Composite gained 43.57 points, or 1.67 percent, to 2,648.72.

The market's rise was foreshadowed by a large jump in stock index futures after weekend data showed China, the world's largest consumer of metals, avoided economic contraction in December.

Also boosting investors' mood was German unemployment, which declined more than forecast.

Indexes held on to gains after minutes from last month's Federal Reserve meeting said a number of Fed officials believed economic conditions could well warrant a further easing of monetary policy.

Among declining stocks, Exelon Corp (EXC) fell 3 percent to $42.07 after a downgrade from Macquarie and other utility shares also lost ground as natural gas futures hit their lowest intraday price since September 2009.

S&P utilities, the best performers last year among the top ten sectors on the S&P 500, fell 1.7 percent.

It was interesting to see how last year's worst performers jumped on the first day of trading and vice versa, how defensive sectors fell back. Along with Netflix and First Solar, talk of a reshuffling lifted shares of RIM. Will 2011's dogs be the standout stocks in 2012?

Who knows, but it is worthwhile noting that even though hedge funds ended 2011 on a very bad note, money keeps pouring into them:

When the history books are written, 2011 may go down as the dark ages for hedge funds.

Last year was dismal for hedge fund performance, according to an index maintained by Eurekahedge, an independent information firm that specializes in hedge fund data.

Amid political uncertainty, the debt-ceiling debate in Congress and mounting fears of a European financial crisis, the Eurekahedge index, which measures average returns, dropped 4.1 percent for the year.

Even as losses mounted, investors continued to flock to hedge funds. In 2011, the industry started more than 1,100 portfolios, the second-highest number in the history of the index, the firm said. In total, $67 billion flowed into hedge funds in 2011, bringing the overall industry size to $1.72 trillion, the report said.

The year was especially rough for some of the biggest names in the hedge fund pantheon.

John A. Paulson, who made billions with his prescient calls on the subprime mortgage market during the financial crisis, apologized to investors in November, saying that that 2011 was shaping up to be the worst-ever at his firm. His Advantage Plus fund, which owns Bank of America and Citigroup, headed into the Christmas holiday down more than 50 percent for 2011.

Jeffrey Altman, the founder of Owl Creek Asset Management, also had an off year, with his flagship fund down roughly 13 percent through November. Fortress Investment Group, a publicly traded hedge fund manager, had its earnings drop by nearly 45 percent in the third quarter with a loss of $382 million.

A lot of hedge funds are battling for survival and they're hungry for returns. Also, the biggest hedge funds in the world -- central banks -- are pumping up the jam, helping banksters profit from money for nothing and risk for free, which is why I maintain stocks and risk assets will soar in 2012, and recommending investors position themselves for La Dolce Beta.

Of course, it will be volatile and a plethora of gurus and experts will be warning us of the end of the world and the 'high-powered' money problem, but ignore them, they are being silly. The world is not ending in 2012 and there is no double-D trouble ahead. There will be stiff headwinds, but the biggest risk of all is being caught with your pants down as stocks and risk assets surge ahead.

Importantly, pay attention to whether the dips are being bought hard, and how the Risk On/ Risk Off dynamics play out in the coming months. This will allow you to gauge risk appetite.

Below, Bill Blain, co-head of the Special Situations Group at Newedge Group Ltd., and Holger Schmieding, chief economist at Joh. Berenberg Gossler & Co in London, discuss Europe's growth prospects in 2012. They speak with Mark Barton on Bloomberg Television's "On the Move."

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