The High-Probability Outlook for 2012

Investors are more uncertain about the stock markets future today than at any
other time during the past six years. Thirty-eight percent of investors polled
by the American Association for Individual Investors are in the neutral camp a
six-year high. Unfortunately, uncertainty is no investment strategy. It takes
fact-based conviction to succeed in investing. So what are the facts?
Volatility: Bad For Stocks Volatility in the past six months has been off the
charts. Volatility is more than just the performance of the Volatility Index or
VIX. Volatility includes the volume and conviction associated with the recent
roller coaster. During the past six months, the Dow Jones has seen 38 (almost
every third trading day) 90% days. A 90% up day means 90% or more of trading
volume and point moves were to the upside, thus a 90% down day is exactly the
opposite. Of those 38 90% days, 16 happened to be to the upside, 22 to the
downside. That is highly unusual. Ive read interpretations stating that
high-volume, 90% up days (also called breadth explosions) are bullish for
stocks. Before drawing conclusions, lets try to decipher the emotions that cause
90% days. Fear, panic and certain news events cause severe down days. Most up
days seem to be caused by positive news rather than a fundamental change. In
summary, we have erratic news-based buying and panic-inspired selling with 58%
of the 90% days being down days (Dec. 19 was the latest). This doesnt look like
the beginning of a new bull market to me. Fundamentals: No Change The U.S.
financial system got into trouble because of falling real estate prices. The
European financial system got hammered by sovereign debt defaults. Now, U.S.
real estate prices continue to fall, and entire European countries continue to
struggle with pure survival. Neither the U.S. nor the European debt crisis has
been dealt with properly. QE2 was all the rage at the beginning of 2011, but its
effect was limited and short-lived. The European Central Banks charter prohibits
outright QE where newly printed money is given to banks. However, the ECB has
expanded its repurchase operation to three years. European banks can borrow
money from the ECB for 1%. With the borrowed money, banks can now do what the
ECB isnt allowed to buy more toxic bonds from Greece, Italy, Spain, etc. At
first glance, this looks like a profitable symbiosis. Banks pay 1% and get paid
3%, 4% or more via their bonds. Unfortunately, banks forget that they should be
concerned about the return of the money more than about the return on their
money. Banks buying more unstable sovereign debt is a short-term Band-Aid but a
long-term recipe for disaster. The expiration date of the long-term disaster
label might well run out early and bite banks and investors in the butt sooner
than expected.