Clock Is Ticking on 3 Year-End Crises

Clock Is Ticking on 3 Year-End Crises

Europe's mess, the US fiscal cliff, and China's economy will produce plenty of volatility as 2012 winds to a close. Here's what I expect, and how to take advantage of the uncertainty, writes MoneyShow's Jim Jubak, also of Jubak's Picks.

So many moving parts for the end of 2012: China's economic acceleration (maybe), Europe's economic deceleration and continuing debt crisis (certainly), and the US "fiscal cliff" and stubbornly slow economic recovery.

Each by itself could change the direction of the financial markets. In combination, they could cancel each other out…or multiply their individual powers.

I think we're likely to see lots of volatility—much of it to the downside. Days that have the smell of investor panic—like Wednesday, when nine stocks fell for every one that rose on the New York Stock Exchange. And we'll see swings from endless worry (like now) to unjustified optimism (give it two weeks).

Let me share a strategy for navigating your way through this maelstrom, and a crisis-by-crisis timeline.

Ready to Move
The strategy (or maybe strategies) I'm trying to follow in this period is one I've advocated before as a way to deal with the extraordinary volatility that comes with the market these days. It builds on the idea of opportunity costs. And it involves selling stocks that look as if they're going to need more than six months to see their upside.

I may like these stocks for the long run, but the opportunity cost of sitting in dead money is too high. That's because I'd like to have some cash so if a great stock I've had my eye on for months (or years) suddenly gets cheap, I'll be able to buy it.

During this period, I'd like to raise my cash for those opportunities not by selling my strongest stocks—that's always a temptation during periods of volatility, when the strongest stocks are the only ones you can sell without a big loss—but by selling those where the potential payoff is furthest away.

What stocks do I want to buy? Those few that never seem to go down, except when the market is really, really in a downtrend. (Take a look at a chart of Middleby (MIDD) since August to see what I mean.)

Stocks that have been knocked down so far in a selling swing that they're now bargains on even near-term prospects. Stocks that could break big to the upside in early 2013 if—as I think likely—growth in China and in the United States turns out to be not exactly strong, but stronger than expected.

Yes, those are ideas that I've recommended before (along with the idea of buying dividend stocks if volatility knocks down the price enough to produce a 5% yield). And they've worked in other periods of volatility this year. Wash, rinse, spin, repeat.

In this column, I'm going to lay out my best guess at timetables for the three big macroeconomic, market-moving events—and suggest how they might fit together. The goal is to give you a road map to the news that will drive market emotions. And then I'll give specific examples to give you an idea of what to pursue and what to shed during this end-of-the year mayhem.

Let's begin with what I call my "timeline to disaster." You can start with any event you chose. Me? I like to start with Europe.

The Europe Muddle
At the November 12 meeting of European finance ministers, Greece didn't get the €31.5 billion ($40.3 billion) it needs to keep the lights on and the banks open after the first week of December. The finance ministers will meet to try again on November 20.

What's likely? Greece will muddle through until then, and at that meeting Greece will get its funding. But the International Monetary Fund on the one side and the European Central Bank and the European Commission on the other will not bridge their differences about extending the deadline for Greece to reduce its debt-to-gross-domestic-product ratio to a sustainable level. That will get put off until the December meeting.

I don't have much hope for a December agreement. There's just too much baggage here: to get to a sustainable level of debt, the ECB would have to agree to write down the value of the Greek bonds it now holds.

And to put any formal extension into place—to agree on what happens after Greece gets its €31.5 billion—Eurozone governments would have to go back to their electorates and explain why they need more euros to fund Greece with no prospect for this move marking the end of the crisis.

I think we're looking at the endgame in the Greek crisis, but no one wants to admit they're playing. The result will be one more payment to Greece—another kick of the can down the road—in December, and then sometime in 2013, the beginning of serious talks about letting Greece exit the Eurozone while keeping it in the European Economic Community.

My call on a euro debt crisis timeline: Worries that Greece will have to shut its doors and that Europe won't act will keep the market on edge through a deal (totally inadequate as it might be) at the end of November. Then elation at a deal (any deal) in December, and then in the early part of 2013, the return of fear as the deal is seen as inadequate.

The US Mess
Now let's move to the United States and its fiscal cliff.

I can quickly recap the worry here. The expiration of the Bush tax cuts (and some stimulus package tax cuts), plus the automatic spending cuts set to go into effect in 2013, would be enough, most economists fear, to send the country back into recession. Some grand bargain involving tax increases, reforms to the tax code, and spending cuts is needed to head off this disaster.

My fiscal cliff timeline: First up, worry, worry, and more worry that the two parties will take us over the cliff. I think that's what we're seeing now.

Second, we'll see a shift to a totally deceptive picture of the two parties acting like responsible adults and working on some kind of consensus solution. We'll watch as the president convenes meetings with business leaders and holds conferences that bring together the leaders of both parties.

That may even take us as far as a draft proposal for avoiding the fiscal cliff sometime during the postelection, pre-inauguration lame-duck session of Congress. I think this stage could well begin Friday, when President Barack Obama is scheduled to meet with congressional leaders.

Third step, that optimism gets trashed when House Speaker John Boehner, R-Ohio, confronts his own party caucus, then announces that he doesn't have the votes to pass anything like that consensus solution.

Step four, I think the market swings to an extreme of pessimism as investors listen to politicians in Washington talk about the impossibility of a solution or the need to take the country off a fiscal cliff in January in order to force a deal. The bottom in this swing comes as some politicians say they don't think the crisis is nearly as bad as everyone says and that going off the fiscal cliff is no big deal.

The question in this timeline is how long the first wave of optimism will last. I think it has a good shot to run through most of the second half of November, as the president barnstorms around the country and Republican leaders in Washington try to sound like the reach-across-the-aisle compromisers that many think the election demonstrated that voters want.

But as we get nearer the end of the year with no deal, I think journalists will start to remind us that Congress doesn't ordinarily work very far into December. And the swing from optimism to pessimism will be heightened by any talk that going off a fiscal cliff would be a good thing, or at least not so bad.

The only thing the markets will have going for them during this period is that pretty much everyone who wanted to sell to avoid potentially higher tax rates in 2013 will have sold.

China, the Joy of a Successful Transition
It's all over, and there was never any shouting. China has announced the seven leaders that will make up the Standing Committee of the Politburo, the highest level of the collective leadership of China.

All the suspense is gone, although overseas experts will spend months trying to figure out which "retired" leaders are pulling the strings. But China can go back to business as usual.

The immediate tasks are implementing policies that will accelerate China's economic growth from a 7.4% rate in the third quarter, and finding a balance among policies that address real desires—access to clean air and water and a more balanced legal system, to name just two demands that have fueled demonstrations recently—with the Communist Party's insistence that it remain the sole source of power in China.

My timeline for China: It looks as if the new leaders are inheriting an accelerating economy, just as the outgoing government hoped. Growth started to pick up in September, and recent statistics are compatible with an increase in growth to 8% in the fourth quarter, and to an even faster rate at the beginning of 2013.

The big challenge in constructing a timeline for China is figuring out when investors will start to believe that growth has reliably picked up. Investors outside China seem inclined at this point to ignore the signs. I think it will take the January release of actual fourth-quarter GDP growth numbers showing the acceleration to create a significant number of new believers.

Sigh of Relief Ahead?
Is that enough volatility in that for you? It's going to be a bumpy ride, no doubt about it.

The only good news I can offer is that if the United States can avoid the fiscal cliff—and I think we will, even if the decisions aren't made until January—then we're looking at a first quarter of 2013 that builds on accelerating growth in China and a huge sigh of relief (and some positive growth) in the United States.

If that projection is reasonably accurate, I'd sure like to have picked up bargains on volatility in the fourth quarter.

What, looking backward from the first quarter of 2013, would I like to have purchased during the big volatility of the fourth quarter of 2012?

• Stocks that almost never go down—if they crack under the pressure of end-of-the-year volatility. I've already mentioned Middleby. Other stocks that fit this category include Precision Castparts (PCP), Nestlé (NSRGY), and Yamana Gold (AUY), all three members of my Jubak's Picks portfolio; ASML (ASML); Svenska Handelsbanken (SVNLF); Paddy Power (PDYPF); and Kroton Educacional (which trades as KROT11.BZ in São Paulo).
• Stocks that crashed by 20% or more on the volatility—though the crash has to be unjustified by individual company fundamentals, of course. Some candidates here (already down 20% or potentially headed in that direction) are Apple (AAPL), Latam Airlines Group—until recently Lan Airlines—(LFL), Yara International (YARIY), Randgold Resources (GOLD), Broadcom (BRCM), and Cheniere Energy (LNG).
• Stocks that will outperform in 2013, even if they don't drop 20% in the fourth quarter of 2012. My candidates here include US homebuilders such as Lennar (LEN) and PulteGroup (PHM); Chinese consumer stocks such as Home Inns & Hotels Management (HMIN) or Cafe de Coral (CFCGF); energy infrastructure stocks such as Schlumberger (SLB), Jubak's Picks member Seadrill (SDRL), Keppel (KPELY), and Ensco (ESV); and emerging-market stocks such as CorpBanca (BCA), Industrias Bachoco (IBA), and Arcos Dorados (ARCO).

And, looking backwards, what would I have sold? Stocks in sectors where supply is just too great and demand is recovering just too slowly for gains in the first half of 2013. Examples would include Corning (GLW), EMC (EMC), Potash of Saskatchewan (POT), and current Jubak's Picks member Polypore International (PPO).

Or stocks that had a good run in 2012, but now don't have a catalyst for moving markedly higher in 2013. Examples would include Novozymes (NVZMY) and Baidu (BIDU).

These lists will all change with the volatility I expect through the end of the year. They're not meant to be definitive, but rather examples of where to look for buys and sells.

I'm not sure that the end-of-the-year period is going to produce a big net move one way or the other. But I am convinced that volatility will make it very interesting.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund , may or may not now own positions in any stock mentioned in this post. The fund owned shares of Apple, Arcos Dorados, Broadcom, Corpbanca, Corning, EMC, Ensco, Home Inns & Hotels Management, Industrias Bachoco, Keppel, Kroton Educacional, Latam Airlines, Lennar, Paddy Power, Precision Castparts, PulteGroup, Randgold Resources, Seadrill, Svenska Handelsbanken and Yamana Gold as of the end of September. For a full list of the stocks in the fund as of the end of September, see the fund’s portfolio here.