Merkin’s Maxim states: “When in doubt, predict that present trends will continue.” It would seem that those who are attempting to predict the markets for 2013 have a lot of doubt. ” More of the same” predictions abound; a slow, grinding recovery continues, housing and technology lead the way, a weak dollar, low yields on U.S. Treasuries, etc., etc. Anyone who has read what I have written this year will be aware that I prefer to be contrarian. It is more risky, for sure, but ultimately more rewarding.
If the underlying U.S. trend is all you care about, then load up on a domestic index tracker, such as IVV or SPY, and hope for around 8-10% at year's end. The fact that you are reading this, however, would suggest that you are either an active trader or one of the new breed of investors that I call “New Occasional Traders.” These are investors who have realized that buy and hold is no longer enough. They have taken control of their own accounts and are more active now than ever, looking to juice their returns with high probability, risk controlled trades.
The problem is that all of the available evidence points to more of the same; it always does. Unexpected events are, by definition, unexpected. Markets are basically forward discounting mechanisms, and the expected outcome is always priced into them. The aim for traders and investors alike then, is to find the things within the prevailing view that have a good chance of panning out differently. This is where there is money to be made.
It is hard not to accept the basic premise of a continued, slow domestic recovery. The U.S. consumer is still easily spooked by bad news and is in the process of deleveraging, creating a drag on growth. The biggest single factor still driving a recovery, however, is The Federal Reserve. We have seen enough QE-driven growth to know what it looks like, and it is becoming easier to envisage. Housing and employment numbers continue to recover slowly. The shock, whether positive or negative, will more than likely come from outside the U.S..
I believe that a negative shock is most likely to emerge from Europe. The headlines regarding the region have receded, but the underlying problems still exist. The Vanguard European Stock ETF (VGK) has been strong in the second half of the year, gaining over 28% from June lows. EUR/USD has also been on a tear, trading above 1.32 for the first time since the beginning of May. Even given the Fed’s declared intention to keep effectively printing money, I wouldn’t be establishing a long EUR/USD position at these levels. European equities could well have an okay year, but I believe the down-side risk is still real. An investment that offers an up-side of moderate growth with a significant down-side is not for me.
On the positive side, conventional wisdom would say that Chinese growth is returning now that their succession issues are resolved, and China could lead a return to robust Emerging Market growth. The problem with this scenario is that it is, to some extent, already priced into the market. The Vanguard MSCI Emerging Market ETF (VWO), for example, has recovered from its collapse in May to be up around 14.5% on the year. The largest Indian market ETF, EPI, has done even better, recovering to show a profit of over 21% since the end of 2011. It is not just a possible approach to fair value, and therefore a limited upside, that worries me about China and India, however. According to IMF data, both are net importers of commodities. While I believe that the Euro is overvalued compared to the Dollar, continuing to add Dollars to the economy has held down the Dollar’s value overall, and will continue to do so. This places upward pressure on commodity prices. It may pay to look at Emerging Market countries and regions that are still net exporters of commodities, such as Russia and Latin America.
The Market Vectors TR Russia ETF (RSX) is up around 10% on the year, but still down about 15% from early year highs. The i-Shares MSCI Brazil Index Fund (EWZ) is still down in 2012, so may represent even better value at these levels. It goes without saying that Emerging Market funds are not for the volatility averse. In the case of net commodity exporters, however, I feel that global conditions will somewhat limit the down-side, and their relatively undervalued state gives some serious potential. In other words, while they may have volatility historically, their current levels allow for a trade where risk can be limited relative to potential reward.
There is a tendency amongst U.S. retail investors to ignore, or underestimate, the opportunities and dangers from the rest of the world. In 2013, if the U.S. economy grinds along as expected, many will be looking elsewhere for opportunities. Awareness now of where those opportunities (both to the down and up sides) could come from may help smart investors to identify them early, and profit accordingly.
Thank you for reading, and I wish everyone a happy, healthy and profitable New Year!