The High-Probability Outlook for 2012

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tdp2664 InvestorPlace Investors are more uncertain about the stock market’s 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. I’ve read interpretations stating that high-volume, 90% up days (also called breadth explosions) are bullish for stocks. Before drawing conclusions, let’s 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 doesn’t 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 Bank’s 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 isn’t 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.