After A Break

I have been caught up in year end and post holiday projects for the last 10 days, and have been away from the blog. I am finally up to date, more or less, and post these words from the lovely Raffles Hotel in Singapore. Tomorrow, after lunch, we get on a Seaboune cruise ship to travel down into Indonesia, and eventually to Bali. My 95 year old Dad is leading the charge, which is remarkable in more ways than I can say.

Some things have shifted in my 10 day absence:

     * Europe has moved from pre-crisis to muddling-through mode, and the equity markets in the US have responded happily. Predictions of decoupling (US from Europe) have been plentiful. Does this make sense?

     * Romney appears to be the unstoppable frontrunner in the Republican primary field, after his impressive win in New Hampshire last Tuesday. Gingrich, aided by an infusion of money to his SuperPac, is beginning to execute a scorched earth attack in South Carolina, calling Romney a vulture capitalist and deriding his claim to having created 100,000 jobs while CEO of Bain. Will any of this make any difference?

     * The economy added 200,000 jobs in December and the unemployment rate dipped to 8.5%. The S&P has risen 11% since mid-December and at Friday's 1289 close is just 5.5% off its summer high of 1364. The start of a bull market?

     * The US has announced tough new Iranian sanctions, using the Fed to block countries and companies that trade with Iran, including as the key target, oil trade. Europe will join us, though it may be 6 months before the sanctions are put in place. Iran in response is threatening to close off the Straits of Hormuz, while we are using back channels (unusual) to tell the Supreme Leader that this is a red line that Iran must not cross. A lead up to war?

Four questions. My personal answers (and remember, these are just my forecasts, and I miss as many as I make): No to all four questions, with comments below.

Europe will not muddle through. If there is no credit event between now and a year from now, then I will be wrong. The ECB has stepped up significantly in providing liquidity to Europe's banks, though only intermittently and indirectly to its sovereigns. This helps a lot, but will not be enough. Much of the Eurozone is already in recession; the rest will follow soon. By itself, this is not disastrous. But as it takes out potential export markets for Greece, Ireland and Portugal, causing their deficits to accelerate, the increased needs of these countries for funding, over and above their current Troika agreements, could break the bank, and cause a sovereign default. The Troika, Greece and the IIF have suspended the "voluntary bond restructuring" talks. Hedge funds have bought Greek bonds in quantity with clear intentions not to accept a voluntary restructuring, and force a CDS triggering event, where they would be paid out in full. Only the IMF (amazing to say) has stepped into the policy zone to declare that an austerity only format will fail, but they have been overruled (up until now) by their Troika partners - the EU and the ECB. Too little vision. Too much austerity. This will not end smoothly.

In terms of the GOP, Romney may lose South Carolina, or he may squeak by, but it is most likely too late to stop him. He will survive the Bain attacks for now, but he will not survive them in November. They go to the heart of his candidacy, which is his claim that he understands how to create jobs from his private sector experience, and that he created 100,000 jobs while CEO at Bain. He did not create 100,000 jobs while at Bain, when the company/plant shutdowns are factored in, and unless Romney releases a detailed summary fat sheet on the 100 or so deals that were done by Bain when he was CEO, this will dribble out in painful, slow form as investigative journalists do the necessary research. Venture capital firms are job creators; private equity firms are not. Bain is both. The deals Romney claims the most job-creating credit for (Staples, Sports Authority) were venture deals. Most of the 100 deals, though, are private equity deals, where the objective is always to squeeze the income statement and balance sheet to create cash flow to service the debt you used to buy the company, and to pay all kinds of hefty management fees so the investors can get their money back. There's nothing wrong with private equity. It's an important part of the capitalist system. Where Romney is way off base is to claim that this private equity work makes him a knowledgeable job creator. It doesn't. This is Romney at his dishonest best.

As for my forecast that if Romney is the GOP nominee that there will be a third party run (50% chance) and from there, a further 50% chance that the Party will splinter, we will just have to wait and see. At this moment, the odds seem to be shifting against it. But does anyone really know what Ron Paul will do? Does even Ron Paul know? It is just too early to tell.

As for the economy, I feel confident in saying that this is not the start of a bull market. The employment number will prove to be a bit of a pre-Christmas, seasonal fluke. Europe is slowing, as is China. Corporate margins and earnings have been stellar in 2011. So isn't it time the historically low PE ratio of around 12 moves back up? I can only say that I don't think so. There is little real demand in the economy. Obama has deftly held off the GOP long knives on budget cuts, but there will be some, even if the President is not contested at the end of February in this drive to extend the payroll tax cut for the full 2012 year. Earnings forecasts will begin to surprise on the downside (already beginning). So 2012 looks tough, even if Europe does muddle through. If there is a credit event in Europe, watch out!

As for Iran, I am an optimist. Their saber rattling in the Straits reminds Joe Klein of North Korea's way of acting when they wanted to talk, but didn't know how to begin the diplomatic conversation. I think he is right, and he also warns us that this is scary stuff. In a big war game a few years ago, to simulate how we would do against a swarming attack on our fleet by small Iranian PT type boats, we lost 16 warships. A 36 mile wide strait is not where you want a US fleet to have to navigate. But Iran knows they would lose, and that their naval, air force, and command and control assets would be wiped out with little apparent gain, as the Straits would be reopened; the oil tanker traffic would restart; Iran's oil exports would be mostly stopped; and the regime would be under serious threat. This picture seems far too risky. I predict real negotiations will begin before summer.

I am told by family and friends that I overdramatize, always insisting that this conversation, or this chain of events, or this specific event is of enormous, even world-changing importance. And I think they are right. Having said that, I think 2012 will prove to be a world-changing year. Major stuff, sometimes unseen or misunderstood in the past, will be coming up, moving into focus and impacting the current flow of events in surprising ways.

A Major Year. So let's get on  with it!