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Friday, December 28, 2012 - 14:30
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Friday, December 28, 2012 - 14:30
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Friday, December 28, 2012 - 14:30

The 4 Things I Learned in 2012 That Could Save Your Portfolio

Friday, December 28, 2012 2:30 PM

By the simplest of measures, it was a good year for stocks.

The S&P 500 rose 12%, extending a bull market that began in March 2009. Yet the bull is showing his age. Sharp gains were offset by mini-slumps, and the market had to grind it out just to finish in the black. On a more granular level, 2012 played out by a different set of rules than preceding years and investors need to heed to shifting winds as they prep for 2013. Here are four key themes that emerged in 2012, and a look at what we might see in 2013.

1. Risk-on and risk-off is all that matters these days
Throughout 2012, market strategists focused on issues such as valuations, sales and profit growth and balance sheet actions such as dividends and buybacks. None of that mattered. Instead, all you needed to focus upon was the current level of certainty or uncertainty. Investors were running scared in the spring when the headlines out of Washington, Europe and China were daunting, but in quieter times, many were in a buying mood. Indeed, a look at the monthly gains in the S&P 500 tightly correlates with the relative fear among investors as they pivoted between embracing risk and fleeing from it.

More recently, investors have been torn between the twin poles of fear (thanks to Washington's fumbling) and optimism (thanks to signs that the consumer end of the U.S. economy may be rumbling back to life). As a result, the S&P 500 is on track to finish just above 1,400 for the third straight month.

S&P 500 gains during first and third quarters, offset by losses in second and fourth quarters

2. China still rules the commodities market
Fears of a slowing economy in China kept a lid on commodities after robust gains in the prior few years. Crude oil fell about $10 a barrel, while copper, aluminum, iron ore, steel and other metals remained mired in a slump that began in the second half of 2011.

Yet signs are emerging that China's economic slowdown has already ended, thanks in large part to an under-discussed stimulus program that resumed China's heady pace of construction. Of course, the most important catalyst for China is the health of its trading partners in Europe, North America and elsewhere, so the commodities picture in 2013 will also be affected by the global economy. Still, it's a fairly safe bet that if China continues to grow at a solid pace in 2013, commodities are likely to rebound nicely in 2013.

An upturn in new home construction in the United States would also be a clear positive for commodities.

3. Lots of cash does not equal lots of deals
The amount of cash parked on balance sheets of S&P 500 firms continues to swell. More than $1.5 trillion is just sitting there, waiting to go to work. That's why many expected to see a boom in mergers and acquisition (M&A) activity in 2012. Yet outside of the energy sector, deal-making was surprisingly dormant.

Conventional wisdom holds that in a slow economy, strong companies like to make acquisitions in order to sustain the growth rates that push stock prices ever-higher. After all, many executives' compensation packages are tied to rising stock prices, and growth-through-acquisition strategies have enriched many executives in the past.

So why has deal-making remained weak? Some blame the disconnect between buyers, who think a still-weak economy should mean low purchase prices, and sellers, who think their businesses will be a lot more robust in a few years and want a full price.

But perhaps the real reason is the economy itself. If you make a big purchase, and the economy stumbles, then you now have two messes to clean up (your own business and the one you acquired). However, if the U.S. economy moves on to firmer footing in 2013 and the macro backdrop for acquisition integration looks more appealing, then all that pent-up cash may finally be put to use.

4. The bond market starts to turn
Perhaps the greatest boost for stocks in 2013 will come from the massive sums of money expected to flow out of the bond market. For much of the past five years, investors have sought the safe haven of bonds, but since interest rates can't really go much lower, bond investors are starting to rethink that proposition. To be sure, the bond market has been rallying since well before the Great Recession of 2008, thanks to steady drop in interest rates that began several decades ago. Looking at this 10-year chart of the iShares Barclays 20+ year Treasury Bond fund (NYSE: TLT), you'd think a bond rally remains intact.

Yet in the past seven months, this fund has moved sideways. A sideways market -- after a stunning bull run -- often signals a slow churn in an investor base from buyers to sellers, and if the U.S. economy is just a bit stronger in 2013, then bond sellers may start to predominate.

Action to Take --> You made money in the market in 2012 if you followed one simple rule: Use rallies as an excuse to sell and use pullbacks as a time to get aggressive. Indeed, multi-month holding periods appear to be the way to score -- and lock in -- gains these days, and that's likely to still be the case in 2013. For example, the market is weakening now as the Fiscal Cliff talks stumble, which is creating fresh entry points as stock drift lower. However, many expect that the resolution to these talks will trigger a solid rally. After all, investors have proven their ardor for stocks whenever uncertainty is removed.

Such a rally may prove to be a time to take profits anew, because as I noted a few weeks ago any Fiscal Cliff deal is likely to be a half-measure. As a result, investors may start to revisit their concerns about the still-expanding level of federal debt in ensuing months, especially if bond yields start to back up.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.