ICangles Investment Post…

In my August post I recommended investors do nothing in terms of stocks. In my view as we end the year, stocks still represent a good value in terms of dividend yields versus bonds, and an investment portfolio should hold a healthy portion of stocks. The S&P 500 index of large cap U.S. stocks is yielding more than ten year Treasuries. So despite the volatility I didn’t argue for selling, but neither did I argue for aggressively adding to stock positions given legitimate concerns about European debt issues. I found it worrisome that the earlier stock rally had broken down, and plausible that a volatile stock market could move any direction—higher, lower or sideways. And for the year it basically did move sideways. But the value and lack of good investment alternatives in my mind argued for doing nothing and holding onto positions.

Some might say recommending doing nothing is a copout. But in investing often the best strategy is to do nothing. In fact an academic study found women outperform men when it comes to investing in stocks precisely because they do nothing—women trade less, hold stocks longer and outperform men who tend to move in and out of stocks more frequently. The outperformance exists even before taking into account tax issues, which is one more reason to actively consider doing nothing. Of course looking into the future there will come a time to do something, but for the immediate future heading into 2012 more of nothing may be in order when it comes to stocks.

In 2011 the stock market basically went nowhere with the S&P 500 index finishing flat, the Dow Jones Industrial Average up slightly, the Nasdaq down slightly and the Russell 2000 barely down. Although it sounds uneventful the year was anything but, as the below chart shows. Volatility was severe as fears over the Euro and European debt issues, impacting credit markets and the global economy, drove stocks on a wild ride. But with little value to be found in commodities, bonds or real estate, and real inflation constantly eroding the value of cash, there simply were no easy answers for investors in 2011 and 2012 is poised to be no different.

On a positive note my firm’s Q3 client letter pointed out that economic fundamentals were actually improving—quarterly growth moved higher, the economy added jobs, the ISM manufacturing index rose, auto sales surged and shipments of core capital goods grew strongly. More importantly the Conference Board’s Leading Economic Indicators Index continued to increase—especially notable as no recession has occurred without the Conference Board’s LEI Index declining for four months in a row. On that note even better news is the Conference Board’s LEI rose in September, October and November. At year end the U.S. economic recovery remains intact, despite still high unemployment levels.

So, I head into 2012 still urging investors to do nothing, and maintain significant allocations to large cap U.S. stocks. If the market were to decline substantially, falling over 30 percent or even better more than 40 percent, then doing something—buying stocks—would make a lot of sense. Many investors seem to forget the name of the game is to buy low and sell high, so a big selloff should typically be viewed as a buying opportunity. Absent a big sell off or a change in fundamentals doing nothing makes a lot of sense. Of course conversely a big rise in stocks in 2012 could mean some selling could be in order depending on the environment.

In my February 2011 post “Don’t Fight the Fed” I postulated that chances were excellent for positive stock market returns in 2011 with that strength carrying into 2012. However, I also stated that market risk could rise in 2013. Although stock returns in 2011 were more flat than positive, they are finishing the year on a strong note, and I do think that strength is likely to carry over into 2012. In that post I declared that accommodative monetary policy from the Federal Reserve was likely to help the economy before possibly hurting it. I still believe that is the case.

So, in 2012 and beyond what am I looking for in order to go from doing nothing to selling stocks? A change in fundamentals, such as those leading economic indicators could do it. A big rise that takes away  the valuation argument for stocks might also. Shifting sentiment that sees investors become much more positive on stocks is always worrisome. Another breakdown in market technicals if a new rally is underway would again warrant serious consideration of moving to a more defensive posture. And given my view that the existing monetary system is in trouble, with real problems around government debt, any new developments in monetary policies are especially critical in my view, especially anything that could lead to rising borrowing costs…. but more on that later in 2012.