Excerpts From Cervino Capital Management 2012 Market Outlook

12/28/2011

The business of forecasting is often a foolish endeavor; financial author and “enfant terrible” Nassim Taleb called the process of financial divining being “fooled by randomness” in his book by the same title.  And yet every year, most financial participants will spend thousands of words dispensing their prognostications about the following 12 months.  Admittedly, I am afflicted by the same disease, although my discretionary approach to investing and trading allows me for a convenient degree of flexibility in changing my positions when it becomes apparent that the assumptions of the original prediction were unfortunately wrong.

This year the dynamic of forecasting seems even more foolish than ever; the European crisis remains largely unresolved and still centerpiece to every future macroeconomic development.  The first quarter in 2012 will see $850 billions of debt to be rolled over and 1/3 of that amount just from Italy.  Should the market continue to keep interest rates above 7% for Italian debt, the pressure on the ECB to intervene in dramatic fashion will probably prove unstoppable.  Any large scale intervention by the ECB should calm markets and ignite a new leg up in gold.  A refusal of the ECB to bend to market and political pressures might prove highly deflationary and possibly result in a reformation of the Euro currency.

The development of the Euro crisis influences all markets with the results of increasing correlations across the board.  The Euro should remain weak but volatile as every time a positive piece of news is leaked by Brussels, Paris or Frankfurt, short covering rallies will continue to occur in swift manner.  Equities all over the world will also remain hostage to Europe.  European stocks seem cheaper than US equities but much closer to the epicenter of the crisis.  US stocks are not tremendously expensive but, in a world of higher correlations, still exposed to a dire recession in Europe and a now manifest slow-down in emerging economies.  The level of EPS for US stocks is also worrying as they seem to be at the top of a positive earning cycle.  One of the faults of fundamental analysis is that things always look best at the top.  However, all considered, US equities might be the default choice for 2012 as they are in a stronger position than European and Emerging Markets equities, more attractive than most fixed income instruments and probably less volatile than I expect commodities to be in the new year.

On the subject of commodities, I expect increased volatility as the result of a few factors: Europe, uncertain Middle East developments after the Arab Spring of 2011 and the MF Global fiasco.  The alleged criminal actions that took place at MF Global leading to its demise and the fumbled handling of the situation by most parties involved, especially the CFTC and the CME, have resulted in a negative structural issue with the commodities market.  The Chicago Mercantile Exchange, the largest commodity market in the world, has seen its trading volume cut by 10% since the MFG bankruptcy.  Part of this decrease is due to some trading funds still frozen at MFG but also to hedgers and speculators looking for alternatives to the futures market.  This is a very negative development as a healthy and efficient financial system needs a healthy, secure and transparent hedging market like futures.

I also expect Master Limited Partnerships (energy infrastructures) to continue to do well and outperform most sectors.  My long term play on natural gas and water remains, in my view, a centerpiece of any long term portfolios.

In conclusion, I will be expecting high levels of volatility in the first quarter of 2012 as we work through the European crisis; I will be monitoring closely the political debate in Europe and the actions (not the words) of the ECB.  Technically, I will also keep an eye to the correlations between the Euro banking sector and gold to spot potential turns in this saga.  Should I see the ECB become more aggressive in its own quantitative easing program, I shall expect gold to once again outperform.    On the equity side, I expect Master Limited Partnerships to remain a favorite buy on most dips.

One last element not to be forgotten is the US presidential election in November.  While not as pivotal as other past elections, the rhetoric of the political debate might turn nasty and prove destabilizing.  However, election years tend to be generally kind to the market as short term policies are hastily put in place to keep the incumbent president on the job.

One thing is for sure…we will not be bored!

Disclaimer: PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS. THEREFORE, NO CURRENT OR PROSPECTIVE CLIENT SHOULD ASSUME THAT FUTURE PERFORMANCE OF ANY SPECIFIC INVESTMENT AND/OR INVESTMENT STRATEGIES MADE REFERENCE TO ABOVE AND RECOMMENDED OR UNDERTAKEN BY CERVINO CAPITAL MANAGEMENT, WILL BE PROFITABLE OR EQUAL THE CORRESPONDING INDICATED PERFORMANCE LEVELS. DIFFERENT TYPES OF INVESTMENTS INVOLVE VARYING DEGREES OF RISK, AND THERE CAN BE NO ASSURANCE THAT ANY SPECIFIC INVESTMENT WILL EITHER BE SUITABLE OR PROFITABLE FOR A CLIENT OR PROSPECTIVE CLIENT'S INVESTMENT PORTFOLIO. HISTORICAL PERFORMANCE RESULTS FOR INVESTMENT INDICES AND/OR PORTFOLIO BENCHMARKS DO NOT REFLECT THE DEDUCTION OF TRANSACTION AND/OR CUSTODIAL CHARGES, THE DEDUCTION OF ADVISORY MANAGEMENT FEES, NOR THE IMPACT OF TAXES, THE INCURRENCE OF WHICH WOULD HAVE THE EFFECT OF DECREASING HISTORICAL PERFORMANCE RESULTS.

HYPOTHETICAL RISK DISCLOSURE: HYPOTHETICAL PERFORMANCE RESULTS HAVE MANY INHERENT LIMITATIONS, SOME OF WHICH ARE DESCRIBED BELOW. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN, IN FACT, THERE ARE FREQUENTLY SHARP DIFFERENCES BETWEEN HYPOTHETICAL PERFORMANCE RESULTS AND THE ACTUAL RESULTS SUBSEQUENTLY ACHIEVED BY ANY TRADING PROGRAM. ONE OF THE LIMITATIONS OF HYPOTHETICAL PERFORMANCE RESULTS IS THAT THEY ARE GENERALLY PREPARED WITH THE BENEFIT OF HINDSIGHT. IN ADDITION, HYPOTHETICAL TRADING DOES NOT INVOLVE FINANCIAL RISK, AND NO HYPOTHETICAL TRADING RECORD CAN COMPLETELY ACCOUNT FOR THE IMPACT OF FINANCIAL RISK IN ACTUAL TRADING. FOR EXAMPLE, THE ABILITY TO WITHSTAND LOSSES OR ADHERE TO A PARTICULAR TRADING PROGRAM IN SPITE OF TRADING LOSSES ARE MATERIAL POINTS WHICH CAN ALSO ADVERSELY AFFECT ACTUAL TRADING RESULTS. THERE ARE NUMEROUS OTHER FACTORS RELATED TO THE MARKETS IN GENERAL OR TO THE IMPLEMENTATION OF ANY SPECIFIC TRADING PROGRAM WHICH CANNOT BE FULLY ACCOUNTED FOR IN THE PREPARATION OF HYPOTHETICAL PERFORMANCE RESULTS AND ALL OF WHICH CAN ADVERSELY AFFECT ACTUAL TRADING RESULTS.