How to describe 2011? Many famous quotes come to mind. First, Charles Dickens, with, “It was the best of times, it was the worst of times.” Also the Grateful Dead, with, “What a Long Strange Trip It’s Been.” I think they both work. The only thing I am certain about regarding 2011 is that I – and I suspect many others – am glad it is over.
2011 was as good as it gets for corporate profits. When one looks at the underlying fundamentals of the companies whose stocks constitute the stock market, one would have thought that 2011 would have been the start of a big bull run. Unfortunately the markets were not driven by underlying fundamentals in 2011; they were driven by geo-political crisis. The headlines suggest that it was a flat year, but for most professionals, ourselves unfortunately included, the headlines paint a rosy picture on a brutally volatile and tough investing canvas of a year.
I have written about this dichotomy several times over the last few months, however, the New Year always makes me feel a little more philosophical about the practicalities of the past twelve months. The details of daily activity tend to drown out the big picture of what we are witnessing. In 2011 we witnessed natural disasters in Japan, an uprising of the desire for freedom in the Arab world, and the start of the collapse of European “Social Democracy.”
The situation in Japan is an isolated event, although these disasters always teach us how fragile human existence is in reality. We go through our lives on a daily basis buckling our seat belts, constraining our children in safety harnesses, and sleeping in air-conditioned and burglar-alarmed houses made to withstand earthquakes and hurricane-force winds. Then we are brutally reminded that the forces of nature are beyond our control. This feeling of insecurity may be more meaningful in the long run than the temporary disruption of supply chains.
The other two phenomena that marked 2011 have more lasting potential. Market reactions in the short term are centered on the flow of oil from the Middle East and the flow of credit in the West. However, the Arab uprisings and the European crisis have more in common than just market movements: they both represent the ultimate failure of societal models that constrain the most basic desire of mankind, freedom. It is most obvious in the Middle East as totalitarian dictators are toppled, one by one, by protesters in the streets.
It is equally true, however, in Europe, where freedom was gradually traded for a false sense of security. Totalitarian rule is a harsher means, but regulatory red tape and unrealistic promises of “free” benefits will deliver the same ends: A lack of freedom, a lack of innovation, and a lack of economic progress. There are only two stages of being in nature, growth and decay. Many falsely believe that economic growth is harmful, or that continual growth means always getting bigger, wealthier, etc. This is not true. New growth is needed to replace the old. New growth is needed to survive. The seeds of demise in Europe were sown long before they dreamed of a common currency.
There is hope in this understanding of what we are enduring. In 2012 we will have our own decision to make: Do we continue down the European path to inequality, economic stagnation and eventual collapse, or do we choose the path of freedom as is our tradition? In Europe they no longer have a choice. There is no more money to spend on the regulatory web and its social contracts; regulatory reform is the only option for both reducing the cost of government and stimulating economic recovery. Social contracts have to be brought back to reality for a lack of resources. In other words, freedom will be increased, and as has always been the case, when freedom rises, economies do as well.
In terms of our day-to-day responsibility, much of 2012 will be spent waiting and watching to see how fast Europe will act and what the United States will decide to do in the meantime. At Iron Capital we are still working on our own forecast, but it is clear that volatility will continue. These days may seem dark for many, but there is hope for the longer term as we enter this new year. It may take some time, perhaps all of 2012 and beyond, but there is a reasonable probability that 2012 will mark a turning point in the trajectory of the West, away from central control and back towards freedom.
Of course it may end differently, but it is a new year so let’s be optimistic.
Happy New Year!
Chuck Osborne, CFA