It’s My Way or the Highway
I am sitting here in front of my screens in utter amusement, befuddled, and gob-smacked. The weekend produced the worst case scenario from the “Fiscal Cliff” front lines: an ultimatum from Treasury Secretary, Tim Geithner, followed by finger pointing from both parties blaming the other for the impending economic disaster. It was a news flash worthy of a 600 point plunge in the Dow. What did we get? A piddling and flaccid 60 points instead.
The failure of the market to go down on horrific news leads me to consider that the ultra bull case for 2013 may be a real possibility. You have to notice that each violence-threatening comment emanating from politicians in Washington are generating market dips of diminishing magnitude.
Over the last five years, some $500 billion has poured out of equity mutual funds and $1 trillion flooded into bond funds. Virtually every category of investor is running equity exposures at historic lows. A reversal of these flows would trigger the mother of all bull markets.
Nobody in the investment community believes that the fiscal cliff will fail to get resolved. The problem is being vastly exaggerated by the media, now suffering from post partum depression that had us all glued to our TV screens during the presidential election. Some outlets are even posting “24” style countdown clocks to the exact time that financial Armageddon hits. Good for TV ratings, bad for your investment returns.
A fiscal cliff Grand Bargain could be the catalyst that triggers the great bond/equity risk reversal. The markets could get a further boost from our country’s rapid conversion to “Saudi America” which will deliver ultra cheap and abundant energy for all. The Fed will raise the safety net, keeping good on its promise to keep interest rates at zero until 2015. It all adds up to a trifecta of good news that will send risk markets soaring.
This trifecta will have a double-leveraged effect on equity prices. Newfound confidence will push US GDP growth to the upper end of the recent range to 2.5%-3%, with much of the growth arriving in the second half. SP earnings will jump from $100/share to $108/share. This will also fuel a multiple expansion from 14X to 15X.
Add all this together, and you get an SP 500 clawing its way to $1,600 or more by the end of 2013, up some 13% from here.
The European Central Bank will continue its never-ending monetary stimulus, allowing the continent to bounce along a bottom at zero-growth, heading off a real crash. Southern Europe will remain mired in recession.
These are not such outlandish forecasts. However, we may have to endure one last hair raising “can kick” into 2013 before the real, sustainable move up starts in earnest.
If this Goldilocks scenario unfolds, you can expect technology, materials, gold, health care, and energy stocks to go through the roof. China finally bottoms, empowered by a new round of its own stimulus spending, now that its once-a-decade leadership change is completed.
These are not pie-in-the-sky predictions, but real possibilities. For that reason, I intend to cover my existing short positions in oil, the euro, the SP 500, and the Russell 2000 on the next serious dip, and tilt more aggressively to the long side. The only remaining short I am happy to continue to cohabitate with is with the Japanese yen.
This dream scenario will probably not run for the entire year. But a good run is certainly in the cards for the first quarter of 2013.
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