Easy Money Now, Hard Times Later

Following up on the last post, "Freight Trained," I wanted to highlight an article in Barron's that outlines quite well the expansionary monetary policies by most large central banks in the world. I agree with many of the concerns outlined in the article and believe these monetary policies, coupled with the fiscal austerity in many countries, lead to the following in 2012:

(1) Rising commodity prices into the first half of 2012, driving up prices for gas and food,
(2) Higher equity valuations into the first half of 2012 as liquidity inflates the stock markets,
(3) Rising interest rates on longer-term bonds due to inflation concerns and rising stock valuations,
(4) Declining wages as companies control headcounts to offset higher material prices, and
(5) Rising CPI by mid-2012 as companies pass along higher costs to customers,

All this leads to a potentially violent reset of the markets in the middle of 2012, in my view, in-line with my expectations under my Sagflation thesis of slow-to-negative growth combined with more volatile prices. During this phase of Sagflation there may be rising fear that we are entering a period of Stagflation, or high inflation, high unemployment and slow economic growth. I suspect this potential period of Stagflation may precede a period of negative growth and deflation in 2013 and 2014. While worrisome, I also believe the years 2013 and 2014 enable the political and economic re-structuring required to set-up for healthy growth in 2015 and beyond.

Returning to 2012, the potentially violent reset during the middle of the year may occur due to:

(1) Consumer spending falling due to a squeeze between rising food/gas prices and declining incomes,
(2) Debt stifling growth in European countries and with US consumers,
(3) Social unrest stemming from economic hardship in Europe and the US (Occupy movement),
(4) Additional austerity measures legislated in the US and enacted in Europe to reduce debt, and
(5) Diminishing impact, or even reversal, of expansionary monetary policies that appear to hurt growth.

These are my opinions and I lay them out in order to refer back to them in the future in order to track how my perception of the future evolves as unexpected events occur.

With all this in mind, I may exit a few positions that do not benefit from the anticipated rise in commodity prices and steepening of the yield curve. My portfolio currently includes the following:

Weight	Name	Ticker
~16%	Proshares Ultrashort 20+ Yr Treasury	TBT
~11%	SPDR Gold Trust	GLD
~4%	Base Metals Double Long	BDD
~4%	Rowan	RDC
~4%	Boardwalk Pipeline	BWP
~4%	Eaton Corp.	ETN
~4%	DOW Chemical	DOW
~4%	Huntsman	HUN
~4%	Prudential Financial	PRU
~4%	Brookfield Asset Mgmt	BAM
~4%	General Electric	GE
~4%	Vale SA	VALE
~3%	iShares Silver Trust	SLV
~3%	Tyson	TSN
~3%	Goldman Sachs	GS
~3%	Ferrell Gas Partners	FGP
~2%	ETFS Physical Palladium Shares	PALL
~2%	Citigroup Inc.	C
~2%	Morgan Stanley	MS
~2%	Pepsico	PEP
~1%	Teva Pharmaceutical Industries	TEVA
~1%	Computer Associates	CA

Twelve Month Outlook - Investors May Get "Freight Trained"

Freight Trained - (Rodeo Term) Being run over by an animal that is traveling at top speed.

Investment Conclusion
I believe the equity markets and commodity prices perform reasonably well, albeit volatile, through much of the fourth quarter due to the recent monetary stimulus injected into the world economy. I also believe the significant sovereign debt outstanding results in each round of monetary stimulus having a diminished impact, reducing its impact in both duration and strength. Therefore, I believe there is a risk that investors move back into the market over the next few months chasing the monetary-driven valuation increases, only to become exposed to a significant correction in 2012 once the monetary stimulus diminishes. To put it more colorfully, investors potentially get run-over when a perceived bull run turns on them.

More specifically, I believe the equity and commodity markets peak at some point in the next 2-3 months and then begin to reverse. Without additional significant monetary stimulus in the first half of 2012 I expect the equity and commodity markets to move sideways to down during the first two quarters. Around mid-year I expect a violent correction in the markets due to one or more of the following causes: (1) decelerating growth associated with austerity, (2) accelerating inflation associated with monetary policies, and/or (3) major sovereign debt defaults associated with excessive debt levels. After this correction I expect equity markets to continue downward for an extended period of time before bottoming with the S&P 500 around 700, consistent with my previous views within my Sagflation thesis.

The following are four points supporting my argument that inflationary pressures move the markets over the next few months:

(1) ECB Switches to Monetary Stimulus
The European Central Bank, ECB, cut rates to 25 bps to 1.25% in a "surprise" move. The takeaway, in my mind, is that the ECB is prepared to aggressively stimulate the European economy through rate cuts over the next few months to offset an economy that is slowing due to the debt crisis. This moves likely drives commodity prices higher and possibly stocks higher due to more liquidity in the world financial markets. The change of course also likely weakens the Euro, although the US dollar also likely continues to weaken relative to a basket of foreign currencies due to the Fed's low interest rates and monetary stimulus.

(2) Europe Appeases Markets in Short-term 
My takeaways from the European Greek debt agreement were: (1) Over $1 trillion may be injected into the market, adding inflationary pressures, (2) market activity was perverted, setting an ominous precedent, (3) maybe contagion has been avoided stemming from Greece but what about Italy and other countries, and (4) a short term solution was created that may or may not accomplish its goals, if implemented at all. In short, the agreement pushes these issues into 2012 and likely amplifies their negative impact next year.

(3) The Federal Reserve Remains Expansionary
While the Federal Reserve did not announce any additional quantitative easing programs, it did say it "is prepared to employ its tools to promote a stronger economic recovery." I believe this wording positions the Fed for further quantitative easing. The Federal Reserve also expects to maintain the low interest rates. While the Fed obviously doesn't want to jump into action at the whim of the markets, it appears more focused on driving growth in the economy. My takeaway is that the outlook from the Fed's position is inflationary since they appear to be shifting to more worry about growth than inflationary.

(4) Japan Focused on Healthy Exports
Japan's central bank is focused on weakening the Yen to aid its export-driven economy. The central bank has agreed that the future purchases of financial assets may be warranted, setting the possibility of a sort of quantitative easing in Japan, adding liquidity and inflationary pressures to the world markets. This implies that each of the three major world currencies are implementing an expansionary monetary policy, increasing the likelihood of inflation building in hard assets, like gold, copper and other commodities. It also likely pushes stock valuations higher, until inflation pressures accelerate above 3-4% in the larger developed economies of the world.
 
My current positions I expect to let run until one of the following occurs: (1) the stock price approaches its 52-week high, which for many of my holding represents over 50% upside; (2) the S&P 500 climbs over 1,375; (5) worries about a sovereign nation defaulting begin to dominate the market; (4) inflation concerns begin to dominate market movements in the US; (5) the yield on the 30-year treasury tips above 4.5%; or (6) 1Q of 2012. Once one of these criteria are reached I plan to begin executing my exit strategy. I suspect the market may move up aggressively through much of the fourth quarter as portfolio managers who are under-performing their benchmarks attempt to make-up the difference, but the last week may prove a much more volatile quarter.

Bought Citigroup on Expectations of European Financial Appeasement

Updating a few trades completed recently.

Today I opened a 2% position in Citigroup (Ticker C) as I expand my exposure to financial companies during the market pullback this morning. My Sagflation thesis has turned inflationary and so I continue to increase exposure to companies that likely benefit from a steepening yield curve. Citigroup's stock was down to start the day largely due to concerns about a solution in Europe. While admitting Europe is a risk to financial markets, I also believe that this week or next Europe arrives at some sort of financial appeasement that satiates the markets for the next couple quarters. I don't expect a solution but instead just enough to make the markets move their myopic focus from Europe. With a forward year PE in the mid-single digits I believe I have some cushion on the downside.

Citigroup Inc. (Ticker: C)

Price Purchased	$30.97	Mkt Cap	$90.8 Billion
52-Wk Low	$21.40	Beta	2.55
CY+1 PE	6.8x	Rating (# of)	Overweight (29)

Citigroup Inc. is a global diversified financial services holding company. Citigroup businesses provide consumers, corporations, governments and institutions with a range of financial products and services. As of December 31, 2010, the Company had approximately 200 million customer accounts and did business in more than 160 countries and jurisdictions.

Kimberly Clark Corp. (Ticker KMB)
Also, yesterday I exited my position in Kimberly Clark (Ticker KMB), booking about a 4% return for holding it about a half year. I exited KMB due to worries that rising prices on commodities may pressure margins going forward. The fact that management lowered revenue growth expectations for 2011 only reinforced my decision to exit the position. My take on the lowered revenue guidance is that competitive pressure is growing from generic brands with lower prices, a concern longer-term.

December Performance - Up 8.5%

For December the balance increased 8.5%, after all fees and dividends received. The performance exceeded the increase in the SP 500, which increased 6.5%. By the end of the month I moved to a more conservative portfolio with almost 30% in cash. For the quarter the value of my IRA increased 13.4% relative to the 10.3% increase in the SP 500.

The largest position remains the inverse 20+ year Treasury ETF (ticker TBT) at 14%. Commodities also account for a significant portion of the portfolio, with the agricultural market basket (ticker DBA) at over 11% and palladium (ticker PALL) growing to 6%. The geographic positions each account for over 4%, with Matthews China Fund (ticker MCHFX) at 9%, Chile (ticker ECH) at just under 5%, and Hong Kong (ticker EWH) at just over 4%. For individual stocks the largest position is Citigroup (ticker C) at just over 4%. The weightings highlight an on-going belief that debt costs likely continue to rise in the U.S., benefiting banks, and commodities and inexpensive manufacturing likely outperform the market, in general.

Every position but two increased during the month, highlighting the breadth of the market rally during the month. GT Solar (ticker SOLR) bounced back after a weak November, increasing 33% up until I sold the position on December 22. American Axle and Manufacturing (ticker AXL) and MKSI Instruments (ticker MKSI) both increased almost 20%.

My positions focused on China underperformed during the month, which I believe is largely due to concerns about a rising interest rate environment. While a short-term concern, I remain confident these positions should perform well due to healthy trends in the Chinese economy and increasing pressure to allow further appreciation in the yuan relative to the dollar.

After such a strong run in December and spotty U.S. economic indicators (notably housing and unemployment causing concern), I expect somewhat of a pullback in the market in the first half of January. I plan to use this anticipated pullback to re-enter positions at more attractive prices.

		31-Dec	Dec.
Name	Ticker	% Portfolio	Chg
RF MICRO DEVICES INC	RFMD	0.0%	11.3%
KULICKE and SOFFA INDS INC	KLIC	0.0%	12.1%
HUNTSMAN CORP	HUN	0.0%	1.3%
FREEPORT MCMORAN COPPER and GOLD INC.	FCX	0.0%	15.9%
GT SOLAR INTL INC COM	SOLR	0.0%	33.3%
DUOYUAN GLOBAL WATER INC SPONS ADR	DGW	1.4%	2.1%
JEFFERIES GROUP INC NEW	JEF	2.9%	10.3%
CA INC COM	CA	1.8%	6.8%
LYONDELLBASELL INDUSTRIES N V COM CLASS A	LYB	2.6%	17.8%
CHINA GERUI ADVANCED MATERIALS	CHOP	3.5%	5.4%
PERKINELMER INC	PKI	1.9%	10.8%
AMERICAN AXLE and MFTING	AXL	0.0%	19.5%
CITIGROUP	C	4.3%	7.7%
EXCEED COMPANY	EDS	3.1%	(7.8)%
MKS INSTRUMENTS	MKSI	2.8%	20.3%
MULTI SECTOR COMMODITY TR PWR DB AGR	DBA	9.7%	11.2%
ETFS PALLADIUM TR SH BEN INT	PALL	6.0%	14.5%
PROSHARES ULTRASHRT LEH BROS 20+ YR TREAS	TBT	13.9%	6.5%
ISHARES INC MCSI CHILE INVESTABLE MKT INDEX	ECH	4.5%	3.9%
ISHARES INC MSCI HONG KONG INDEX FD	EWH	4.3%	0.2%
MATTHEWS CHINA FUND	MCHFX	9.0%	(2.1)%

Citigroup (ticker C) Exits Government Bail-out

Citigroup, ticker C, is rallying after the company announced plans for a follow-on offering to exit the government's ownership position in the company. Obviously the market likes the announcement, and I concur with the following points: the deal removes stigma of government ownership, the deal removes conflicts between company interests and taxpayers' interests, it removes a known large seller, and it likely increases ownership by funds. All-in, a positive announcement that likely takes some time to exhibit its deeper benefits.

No plans to change my ~4% position.

Citigroup (ticker C)

Established a 4% position in Citigroup, ticker C, at $4.39.

Reasons for buying include its large exposure globally, which should benefit from growth in Asia and South America; a potentially steepening yield curve associated with an improving outlook in the U.S. that should benefit the company domestically; and a C2011 P/E under 10x.

The stock continues to creep closer to $5, which should enable a wider group of funds to invest in the company. In many cases, funds avoid stocks under $5 due to internal rules, higher transaction costs, and the perception of poor quality.