Issue 76 - January 9, 2012


2012 - The Continuum

As with any New Year, early day’s optimism abounds and financial pundits look forward with a clean slate. However, the economic episode which began in earnest in 2008 continues into yet another season.

Domestic stock returns, broadly speaking, were modestly positive for 2011 for the largest companies while smaller cap and international names were lower on the year. Bonds defied virtually everyone’s expectations (with the exception of yours truly) and finished the year with strong performance. Municipal names were a standout with lower levels of issuance and improving controls at many state and local municipalities. Quality and income across asset classes were by far and away the best performers.

The single most important take away from 2011 was further confirmation that we are midstream in this deleveraging cycle. There is no arbitrary division or differentiation that comes with the turn of the calendar. The many challenges remaining are now that much more fully appreciated domestically and abroad. Progress has certainly been achieved particularly at the individual company level, however some seriously heavy lifting lies dead ahead.

Europe - Working in the Injury Time

In our initial 2011 newsletter, we wrote that the financial limitations surrounding the P.I.G.S. would dominate the news in the early part of the year. In fact, this was topic number one for virtually the entire year as the interwoven crisis of European sovereign debt and impaired bank capital marched steadily on. European leaders and the central bank spent much of 2011 searching for an elusive all-purpose solution. In late November, coordinated actions were required by every major global central bank to provide US Dollar based liquidity to the European banking system. These efforts did a good job of easing the immediate risk of a modern day bank run for which the leaders should be congratulated. But the first half of this year brings a tidal wave of sovereign debt refinancing requirements along with a commensurate need by the banks themselves.

In anticipation of the looming credit needs, the ECB on December 20th loaned €489 Billion ($635BB) to a total of 523 banks for three years at 1%. While these loans were theoretically without conditions, the central bank expectation is for the subscribing banks to use these low cost loans to purchase sovereign bonds. The banks may have ideas of their own however to use these loans to retire other higher cost sources of funds. But there will be no shortage of political hard ball brought to bear to “encourage” the banks to fully participate in this wave of sovereign debt refinancing. Spain has been rumored to have simply told their banks that their charters would be revoked if they did not participate and Spanish yields have fallen as a result. But Spain has relatively small amounts coming due in this cycle. The “pig in the python” is Italian debt and the Italian banking complex is just not large enough on its own to ensure a successful auction.

Setting aside the liquidity imperatives, effectively restructuring unserviceable debts while maintaining the integrity of the confederation and the functionality of the banking system, remains the main hurdle for the Euro Zone.

"Risk On - Risk Off"

Investing is best not left to cheerleading slogans. “Green Shoots” gave way to a “V Shaped Recovery” and when that did not pan out, pundits were uniformly “surprised” and “disappointed” by data which portrayed a “sluggish” economy. The extraordinary volatility witnessed in 2011 was watered down to the expression of “Risk On” for positive days and “Risk Off” for down days. What total nonsense. There is nothing simplistic about untangling the web of an over extended global credit complex. The reason the sovereign debt crisis has proven to be so intractable is that the solutions fall between choices best described as bad and worse. The common currency was inherently flawed and the treaty provided no mechanisms for either enforcement or restructuring. The tool box is therefore limited and any combination of solutions will have far reaching implications.

There are those who hope or advocate that the US has “decoupled” from the European markets. That is so much wishful thinking. The US market has had a head start on what lies ahead for Europe and that is certainly to our advantage. The balance sheets of US non financial corporations are in terrific shape, especially the largest companies who have had access to low rates through the capital markets. But these companies operate on a global basis and if their trading partners in Europe or China or elsewhere experience slowdowns – they will be impacted.

The emerging markets remain a bright spot – but they too trade with Europe and they also get a significant percentage of their credit from Euro Zone banks. These 523 institutions are going to be hard pressed to expand their lending while they are simultaneously trying to delever while still purchasing the new bonds of the P.I.G.S. coming to market. Something has to give and it is likely to be credit lines. This is precisely what we have experienced here in the US. Our banks have had ample cheap funding but have been loathe to lend it to anyone save for the best credits. Rather, they work through their problems and continue to slim down their balance sheets.

The Euro crisis will act as a headwind for some time to come and to pretend otherwise is to be intellectually dishonest. However, headwinds are merely that. Businesses around the globe have been working in these current conditions for some time with plenty of success. The question facing investors is how much to pay for that success while allowing for a discount of some magnitude in consideration of any disorderly events coming out of Europe.

The Road Ahead

It has now been almost four years since JP Morgan absorbed a failing Bear Stearns over the course of a March weekend. It is understandable that investors have grown weary of the volatility and the false promises of a return to the good ole days of investing circa 1999. Worries over inflation bred from excessive Federal Reserve liquidity efforts have given way to negative rates on the shortest of US T-Bills. Safety has become scarce. Safety however is in the eye of the beholder. Portfolios of high quality equities and long term bonds have proven to be far more effective than those comprised of cash or short bonds.

US economic data has been slowly but steadily improving. Interest rates are at generational lows and equity valuations are subdued. Consumers have embraced their own forms of frugality but this is a far cry from retail abstinence. Not a rip roaring back drop for investing but not without its own merit.

This brings us back to our original premise; we continue to find ourselves in the midst of what will likely remain for a significant period of time to come, a challenging investing environment. Sell side enthusiasm, political posturing, and CNBC sloganeering collectively will not alter the reality of global economic activity.

Resilient high quality portfolios that feature strong income components have shown their ability to ride through this episode despite having had the kitchen sink of volatility thrown at them. 2012 may or may not feature some amount of geopolitical upheaval but the backdrop of that worry will be omnipresent. We believe our intellectually honest approach to conservative stewardship will continue to reward our clients and to help us navigate the uneven road ahead.

Best Wishes –

Jen & Patsy


In this Edition

  • 2012 - The Continuum
  • Europe - Working in the Injury Time
  • "Risk On - Risk Off"
  • The Road Ahead

Huntington Steele

925 4th Avenue
Suite 3700
Seattle, WA 98104



Past Issues

75 - 12.05.11
The Problem/ What Could Go Wrong/ Compound Interest/ Germany or Bust/ The Cavalry/ Stress Tests/ Next Chapters/ MF Global

74 - 09.29.11
Broken Transmission/ Chickens and Eggs/ Where to?

73 - 08.29.11
The Confluence/ The ECB/ US Economy - Distinction without a Difference/ A Different Kind of Exit/ Gold as a Thermos/ Where to Now?

72 - 06.28.11
Sovereign, Central, Commercial/ Why we call them "Banksters"/ "Extended Period" just got a lot longer/ Forward.

71 - 05.24.11
The Question is... How Many Years?/ "Unexpected" Housing Weakness/ P.I.G.S. Can't Fly/ Stages.

70 - 04.11.11
Inflation for thee, but not for me/ On the Other Hand .

69 - 04.05.11
Implications - A Bevy & A Wedge/ Implications - Quantitative Easing 2.0/ Implications - Rules Rules Rules/ Catching Up with the Can.

68 - 03.03.11
What Ever Happened to Housing?/ Where Do Loans Come From?/
Where Do Loans Go?/ The Last Straw/ The Path Forward/ Equity/ Clearing Mechanism/ Restart Your Securitization Engines.

67 - 01.10.11
Curiosity of the Federal Reserve/ Complacency & Fragility

66 - 11.12.10
Phew/ Taxes and Employment/ Quantitative Easing Returns/ Incentives & Unintended Consequences/ Dear Mr. President

65 - 09.28.10
Progress in the Absence of Milestones/ Changing Nature/ Correlations & Valuations/ Synthetic Securities

64 - 08.18.10
A Tricky Diagnosis/ Traditional Treatment/ Bad Medicine/ New Age Medicine/ Homeowners/ The Banks/ Pension Plans/ Bull Flattening

63 - 06.17.10
Hip & Groovy/ The Trouble with Zombies

62 - 05.24.10
Next Sequel/ 2012

61 - 05.04.10
Intensity/ Principles versus Rules

60 - 04.01.10
Grand Isle to Lincoln
/ Mile Post 312/ Mile Post 353/ Mile Post 399/ P.I.G.S. are a Problem

59 - 02.17.10
Surprise, Surprise, Surprise/ P.I.G.S. Matter/ Leverage vs. Debt/ Going Forward

58 - 12.29.09
2009-The Year in Review/ 2010 - The Year of "The Exit"/ Deflation or Inflation?/ 4 Cylinder Economy/ Rates and Returns

57 - 11.04.09
Banks-Back to the Future/ Navigating the Tsunami/ TARP 3.0/ Implications

56 - 09.15.09
Are We There Yet?/ The Beginning? The Present/ The Journey is the Destination

55 - 08.04.09
A Transformation is not a Recovery/Not All Economic Data is Created Equal/
Smallest, Lowest, "Shortest"

54 - 06.24.09
Aftershocks/ Fragility/
Inflation and the Fed

53 - 05.29.09
A Brave New Road to Recovery/ Vehicle Choice/ Speed Limits

52 - 04.07.09
The Things We Know/The Things We Don't Know/Savings and Sensibility

51 - 03.25.09
The Correct Problem/ The Need for Speed/ No Good Deed Goes Unpunished

50 - 03.05.09
Rebuilding Credit/ Under Repair/Problems Persist/Big Chore

49 - 01.12.09
The Year in Review/ The Path Forward/ 2009


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Market Highlights



12/31/10 12/31/09 12/31/08 12/31/07 12/29/06 12/30/05 12/31/04
11,578 10,428
S&P 500 US


1,258 1,115


Nasdaq US
2,653 2,269
EAFE Int'l Equity
1,658 1,581


5 Yr Treasury .85 2.02 2.71
5 Yr AAA Muni .94 1.75


10 Yr Treasury
3.38 3.92
10 Yr AAA Muni
3.44 3.26
30 Yr Treasury 2.914 4.325
30 Yr AAA Muni 3.82 4.9
EUR Currency 1.29 1.34
JPY Currency 77.36 81.32


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