The Year of the Water Dragon
Posted by Charles II on January 1, 2012
(Photo by wili_hybrid of Viele Miettine dragon in Vic, Ljubljana, Ljubljana, Slovenia
Creative Commons 2.0 License)
First, to ‘fess up to last year’s predictions:
* US markets have a decent first half and a bad second half. [True]
Financials, fixed income, and consumer stocks do the worst and hard assets (but not oil) do the best. [Financials tanked, but so did many basic materials, which are hard assets. REITs, which represent property values, did better than the market, though Case Shiller is flat or declining. Oil was mixed, but basically flat for the year. US fixed income did fine, and risky fixed income, like Italian bonds, not so much. So score this prediction as half-right].
Even among the hard assets, the metals have run too far, and should correct. [Gold did correct slightly, but then ran up to finish +10%. Silver, palladium, and platinum tanked. The graph added below shows this. The S&P ended up, with oil, essentially unchanged]
Healthcare companies continue to mint money. [No question about that. The S&P healthcare index ended up by 10%]
By the end of the year, unless the Republicans fall to looting, a second Great Depression looks very possible.[This was an excellent prediction. While the Republicans were genuinely trying to enact the Tea Party agenda, they brought on the debt crisis and seriously shook confidence. When they turned back to simply looting the Treasury, things improved.]
* Europe has a serious scare, including financial panics on the periphery. That may force serious reforms, though whether of purely the impoverish-the-middle-class or the let-countries-float-their-currency variety is unclear. If there are no serious reforms, expect the Eurozone to fragment in the medium-to-long term; a new wave of radicalism, both left and right, could also emerge.
The Russian and German economies do the best, but there’s enough ugly everywhere to meet any appetite. Bonds and financials lead the way down. [The latter is an extremely good prediction. The German economy certainly did well. I'm less certain about Russia, but this source said it outperformed advanced economies.]
* Latin America and Asia have the best time of it, but even there, it’s a nervous time, with volatility especially high in Asia. Both Brazil and China emerge as clear world leaders as US influence in Asia declines. Japan gets extremely nervous; it’s possible ultranationalism re-emerges as a serious force. [Terrible prediction. The Latin American ILF and IShares China indices are down 20%. Japan is nervous, but not so much because of market volatility.]
So, there are basically two scenarios. First, if nothing bad happens, then anyone invested in the market makes money, but especially in Asia. The world economy gradually recovers. Bonds fall. Commodities continue to be a good investment.Or, if a lot of bad things happen, depression and deflation become the big concern. Bonds continue to rise. Most commodities fall, though some hard assets maybe not. Asia gets hurt, especially export-dependent countries.[This is actually fairly accurate. The reason that Asia and LatAm got hammered is because they are high-beta regions: when things are good, they're very, very good, and when they are bad, they're a disaster.
Now, despite a fairly good set of predictions, my own performance was terrible. I did not expect Europe to be so bloody minded about imposing austerity, which nuked investments in LatAm and Asia. I did expect more serious repercussions in the US, especially when the GOP tried to march the nation off a cliff. I made the mistake of jumping in too early on basic materials and utilities when the market tanked. Small stocks did abysmally: the Russell was down about 5%. I had some major losses there, particularly in Chinese stocks, where there was the additional problem of dicey accounting. So, where the S&P was even, I am down 5 points for the year.
So, now for the coming year. According to the Chinese Wu Xing (which, again, I don’t believe has any predictive power), we are out of the metal cycle and into water for two years. Water represents the full yin, or passive, element. This stands in contrast to the Chinese Zodiac’s Dragon, “the mightiest of the signs. Dragons symbolize such character traits as dominance and ambition. Dragons prefer to live by their own rules and if left on their own, are usually successful. They’re driven, unafraid of challenges, and willing to take risks.” So, water dragons are pretty tame dragons, but the Year of the Dragon is a lucky year.
I remain pessimistic about the world economy. I don’t think the basic problems in the West have been solved, and serious problems have emerged in Asia with the nuclear crisis in Japan and the housing bubble in China. War with Iran represents a major economic risk for the US, since it’s very unlikely to be the quick surgical strike our politicians imagine.
South America is doing reasonably well, but the right is rising, so it’s unclear how long the good times will last. Southern Europe is clearly in for hard times, and this will limit Germany’s export machine. The brightest spot for the next few years may be North Africa, assuming that democratic governments eventually emerge.
So, I see the same two paths open before us that there were last year. On one path, the Chinese allow their currency to float and the consumer economy to take root. The Germans stop trying to punish southern Europe. The US gets the dead hand of the Republicans off the economy and does something for underwater homeowners. Japan bites the bullet and goes solar. Under this scenario, a true recovery begins, and a true bull market takes hold. On the other path, the political system continues its now-epic FAIL, recovery turns into recession, and the bull market is pushed off for years. In the
formerlatter case, making money in the market is all but impossible for the small investor. In the latterformer case, everything does well, but especially industrials, basic materials, energy, staples, and services:
(Image from Stocks for Beginners)
So, which is the Year of the Water Dragon? If you believe in Chinese astrology, it’s a good year to make money. If you believe in the stupidity of politicians, things do not look good.
I know which of the two I believe in.
Added. Morgan Stanley produced a chart of who owes debt.
(reproduced by Steve Keen, Business Insider)
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