The More Things Change - Year in Review

The more things change the more the stay the same

Ah, is it just me or does anybody see

The new improved tomorrow isn't what it used to be

Yesterday keeps comin' round, it's just reality

It's the same damn song with a different melody

The market keeps on crashin'

The More Things Change - Bon Jovi *NEW 2010* (FULL VERSION)

If you weren't paying attention you'd say 2011 was a pretty uneventful year in the markets. The S&P 500 started the year at 1257.64, and finished the year at 1257.60, the smallest annual change ever. For those of you who were paying attention, you are well aware that 2011 was a hell of a ride. In fact, it was the 17th most volatile year in history (at least since 1928). Sort of like getting on a roller coaster, screaming wildly as you are thrown upward and downward at dizzying speeds, only to get off at exactly the same spot you got on. The following table highlights the magnitude of 2011's volatility:

All eleven years from 1929 to 1939 are in the top 16, as well as 1987, 2000, 2002, 2008, and 2009. 2011 comes in at number 17.

The following graph is our depiction of Risk-On and Risk-Off. The horizontal axis is the securities correlation to the S&P 500, a correlation of 1.00 means the security moves in tandem with the S&P 500. A negative correlation means the security moves in the opposite direction as the S&P 500. The vertical axis shows each securities total return for the year 2011. In our portfolio the best performing asset was US TIPS, up 13.28%. The worst performing asset was Emerging Market Equities, down 18.73%. The size of each bubble reflects our year-end allocation to each security. Obviously we ended the year in a fairly defensive position with 33.5% in cash.

The following table is sorted by correlation to the S&P 500, with the Vanguard Total Stock Market ETF (VTI) at a perfect 1.00 correlation. 

Some interesting observations:

While quite a few assets had correlations greater than 0.80 (pretty correlated to S&P 500), their performance was very divergent. Equity commodities and international equities did horribly, while higher yielding securities like REITs, High Yield Bonds, and energy MLPs, did relatively well.

More defensive securities like gold and fixed income did relatively well.

Huge divergence in performance between the yellow metal Gold (GLD up 9.57%) and Gold Mining stocks (GDX down -16.09%)! 

Thoughts on 2012:

As I said in my last email, I'm not in the prediction game, I'm in the observation game. Here are my big observations as we head into 2012:

The US and most of the developed world spent 60 years leveraging up, and promising more than they could deliver.

We have hit a tipping point and a massive global de-leveraging is upon us. This will take years, maybe decades, as we go through fits and starts.

The most likely outcome is very moderate economic growth, and very low interest rates. Savers will continue to be penalized in favor of debtors. (Remember the government is the biggest debtor).

Currencies will be devalued as a way of devaluing sovereign debt loads. 

Political manipulation of the markets will remain at high levels as governments continue to renege on their promises.

Volatility should remain at relatively high levels.

We will remain defensive, diversified, and willing to reallocate assets to securities/assets that can rally. I'm not bearish, I'm not bullish, I'm agnostic. I'll take what the market gods give us, and step to the side when they give us nothing. The more things change the more they stay the same. 

Be careful out there, and keep the lights on,

Chris Wiles, CFA

412-260-7917

www.rockhavencapital.com

For prior Rockhaven Views visit:

www.rockhavencapmgmt.blogspot.com

This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management.  The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

Roll The Bones

We go out in the world and take our chances

Fate is the weight of circumstances

That's the way lady luck dances

Roll the bones

Rush - Roll the Bones

The silly season is upon us again. That time of year when Wall Street pundits bring out their crystal balls, dust them off, and predict the markets future. This annual ritual never ceases to amaze me, not that people try to predict the future, but that normally sane people actually listen to them. As Yogi Berra once said, "Its tough to make predictions, especially about the future." 

There was a time when I was paid to make these forecasts too. I tried to take as much guesswork out of it as possible, I'd use mathematical models and regression analysis, and I'd come up with a story and a number that sounded logical. But no matter how hard I massaged the data, the fact remained the same, no one can predict the future. 

Last year the Wall Street strategists predicted that in 2011 the S&P 500 would rise by about 9%, with a range of 0% to 18%. With an incredibly wild ride the S&P 500 is up about 1% on the year. I guess that's within the range, but it's certainly not helpful. 

I'll admit that it once was a tad easier to at least get close to a factual number. In the old days you could look at the economic cycle, make a reasonable estimation of sales growth, profit margins, and earnings, assign a P/E multiple and come up with a pretty plausible estimation of the markets expected performance. 

There is actually no hope of that today. While sales growth, profit margins, and earnings are still relevant variables, their significance in determining potential market returns has been greatly diminished. Today the known unknowns trump any company specific data. Will the euro zone breakup? Will China's economy slow too sharply? Will bipartisan squabbling in Washington derail our nascent recovery? In the first three months of the new year, Italy needs to raise about $172 billion to pay holders of existing debt coming due. Will they or won't they? And if they do, at what price to theirs and Europe's economies? Roll the bones.

That's just a light touch on the known unknowns, what about those pesky little unknown unknowns? Those events that hit us once every hundred years that seem to be happening at least every 18 months. This year we had a devastating earthquake and tsunami, an Arab spring which saw several monarchies tumble, and the marriage/divorce of a Kardashian. Not all unknowns are catastrophic though, some like the accession of Apples iPhone, iPad, and social media have been godsends, except for Blackberry, Eastman Kodak and numerous middlemen. Unknowns can change the world in good and bad ways, the only certainty is change. What unknowns will impact 2012? Roll the bones. 

So much of the last couple of decades growth was driven by a massive increase in debt, derivatives, and fiat currencies. It is clear that we have reached a tipping point in the growth of this debt bubble, but how it deflates and the pain it inflicts are still unknown. It is my expectation that volatility and turmoil will be as much of our 2012 as it was in 2011. We will continue to be defensively positioned and flexible. Our goal remains to be in harmony with the markets, participate when they are working, and standing to the side when they are not.

Here's a prediction for the New Year that I'll hang my hat on, "I predict future happiness for Americans, if they can prevent the government from wasting the labors of the people under the pretense of taking care of them." -- Thomas Jefferson

Happy New Year.

Be careful out there, and keep the lights on,

Chris Wiles, CFA

412-260-7917

www.rockhavencapital.com

For prior Rockhaven Views visit:

www.rockhavencapmgmt.blogspot.com

This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management.  The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

Yes Virginia There Is A Santa Claus ... Rally

Tis the season for hope. 

Our markets have recently morphed from Risk On/Risk Off to Hope On/Hope Off. 

It's Christmas time, tis the season to put our worries on the back shelf and suspend our disbelief. 

Thanks to Art Cashin of UBS for reacquainting us with Virginia's original letter:

A Needed Seasonal Note - As we all hopefully recall, young Virginia O’Hanlon wrote to the New York Sun in 1897 to inquire if there really was a Santa Claus. Herewith - the letter and response.

DEAR EDITOR: I am 8 years old. Some of my little friends say there is no Santa Claus. Papa says, 'If you see it in THE SUN it's so.' Please tell me the truth; is there a Santa Claus?

VIRGINIA O'HANLON.
115 WEST NINETY-FIFTH STREET

VIRGINIA, your little friends are wrong. They have been affected by the skepticism of a skeptical age. They do not believe except [what] they see. They think that nothing can be which is not comprehensible by their little minds. All minds, Virginia, whether they be men's or children's, are little. In this great universe of ours man is a mere insect, an ant, in his intellect, as compared with the boundless world about him, as measured by the intelligence capable of grasping the whole of truth and knowledge.

Yes, VIRGINIA, there is a Santa Claus. He exists as certainly as love and generosity and devotion exist, and you know that they abound and give to your life its highest beauty and joy. Alas! how dreary would be the world if there were no Santa Claus. It would be as dreary as if there were no VIRGINIAS. There would be no childlike faith then, no poetry, no romance to make tolerable this existence. We should have no enjoyment, except in sense and sight. The eternal light with which childhood fills the world would be extinguished.

Not believe in Santa Claus! You might as well not believe in fairies! You might get your papa to hire men to watch in all the chimneys on Christmas Eve to catch Santa Claus, but even if they did not see Santa Claus coming down, what would that prove? Nobody sees Santa Claus, but that is no sign that there is no Santa Claus. The most real things in the world are those that neither children nor men can see. Did you ever see fairies dancing on the lawn? Of course not, but that's no proof that they are not there. Nobody can conceive or imagine all the wonders there are unseen and unseeable in the world.

You may tear apart the baby's rattle and see what makes the noise inside, but there is a veil covering the unseen world which not the strongest man, nor even the united strength of all the strongest men that ever lived, could tear apart. Only faith, fancy, poetry, love, romance, can push aside that curtain and view and picture the supernal beauty and glory beyond. Is it all real? Ah, VIRGINIA, in all this world there is nothing else real and abiding.

No Santa Claus! Thank God he lives, and he lives forever. A thousand years from now, Virginia, nay, ten times ten thousand years from now, he will continue to make glad the heart of childhood.

OK, those of you who've been faithful readers know I have a very long list of concerns (the naughty list). This list not only applies to financial markets, but also toward social and political issues. But for the next several days I'm going to suspend those concerns and hopefully embrace this Santa Clause rally. Those concerns will quickly make themselves known as we enter the New Year. Until then I'll leave you with a little humor and a wish for a very Merry Christmas.

Be careful out there, and keep the lights on,

Chris Wiles, CFA

412-260-7917

www.rockhavencapital.com

For prior Rockhaven Views visit:

www.rockhavencapmgmt.blogspot.com

This article contains the current opinions of the author but not necessarily those of the Rockhaven Capital Management.  The author’s opinions are subject to change without notice. This article is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.