Monday, January 9, 2012

From my perch, the consensus view is that the markets will move higher in the second half of 2012 but will face headwinds over the first half of the year. By contrast, a contrarian view would be for a near-term move to the upside -- putting offside most who are waiting for summer/early fall to expand market exposure.

To reiterate, I wouldn't be surprised to see AAPL trade over $500 this year, based on continued above-consensus volume growth in the iPhone and iPad. Profit forecasts for 2012 could rise to nearly $50 a share (up about 60%). In the second quarter, I wouldn't be surprised to see Apple pay a $20-a-share special cash dividend, introduce a regular $1.25-a-share quarterly dividend and split its shares 10-1. Jobs is gone. Cook will handle the stock much differently, in my opinion.

The SEC is playing hardball, as several high-level insider trading cases have advanced recently; these cases could reach some of the most prestigious hedge funds around.

As we enter 2012, the optimistic economic and market consensus of a year ago has turned far more subdued. Reflecting more downbeat economic growth and investor expectations, individual investors (taking another $100 billion out of domestic equity funds) and hedge funds (now at their lowest net long exposure since the Generational Bottom in March 2009) have materially de-risked.

Consensus rarely triumphs in the stock market, and I see 2012 as another year in which the consensus will be wrong.

While I fully recognize the world is imperfect, the blemishes are now well known and, arguably, incorporated in current share prices. More importantly, three pressing concerns (high volatility, a mounting European debt crisis, a weakening domestic economy and the division between the Republican and Democratic parties) are moving in the right direction. And, the fourth, our divided leadership incapable of compromise, might now be coming closer to resolution with a country that appears to be leaning toward the Republican party. A close Romney win has been my baseline expectation for over a year, and such a political outcome would be more market-friendly than would occur with another four years under President Obama.

In Europe, political leaders and central bankers are slowly addressing their sovereign debt problems. Very slowly. Though tame and timid in approach at the outset, more "shock and awe" has been employed -- and more is likely on the way. It is my view that the eurozone affliction is moving toward a condition that can be tolerated by the markets (but must always be monitored).

Another market-friendly condition is that central bankers around the world have signaled increasingly accommodative monetary policies. With inflation quiescent, low short-term interest rates are likely to remain for some time.

With better economic growth ahead in the U.S. and the hope for some stability in Europe, a meaningful rotation out of bonds and into stocks is a growing possibility. U.S. stocks have had an average P/E multiple of 15.3x over the past 50 years, while the yield on the 10- year U.S. note has averaged 6.67%. Today, U.S. stocks trade at only 12.5x with the yield on the 10- year U.S. note at around 2%. Moreover, historically U.S. stocks have been valued at 17x-18x when interest rates and inflation (and inflationary expectations) are around current levels.

Risk premiums (the earnings yield less the risk-free cost of capital) are now elevated and back to levels last seen in 1974 as European sovereign debt issues have accentuated the flight to safety. It is important to note that following the last spike in risk premiums 37 years ago, the S&P 500 index returned +35% and +19% in 1975 and 1976, respectively.

These low stock market valuations (mentioned above) will likely serve as a margin of safety for stocks. I also believe strongly that conditions have evolved over the near and intermediate term that have conspired to favor risk assets in the U.S. over many other areas of the world.

To summarize, I believe 2012 will be a surprisingly good year for the U.S. stock market. I anticipate that domestic economic and profit growth will surprise to the upside, and I am of the view that market valuations will expand (after contracting in 2011). If Europe settles down, the flight to safety of 2010-11 should become a thing of the past this year, and fixed-income instruments could take the brunt of the damage in a potentially large reallocation out of bonds and into equities.

I fully recognize that the slow worldwide economic growth exposes economies and markets to exogenous shocks, but I also think much is discounted in current prices.