Macroeconomic risk dominated 2011, as global financial markets rose and fell in response to headlines out of Greece or Washington D.C., rather than to economic fundamentals. When markets close on Friday, December 30, it is likely that only the U.S. and the Indonesian stock markets will end 2011 in the black.
With that caveat, below are my three big-picture investment predictions for 2012, along with some recommendations on how you can make money from them.
The U.S. Stock Market Will Recover... as Will Most U.S.-Based Assets
In a global context, U.S. assets, such as real estate, the U.S. dollar or stocks, appear remarkably undervalued.
There are two reasons for this. First, the U.S. economy is the best among a bad global bunch. The Conference Board Leading Economic Index (LEI) for the U.S. has now increased for three consecutive months. That means the U.S. has avoided a double-dip recession and, the recent slowdown notwithstanding, it is unlikely to enter one for a while. In contrast, much of Europe is already there, growth is slowing sharply in Asia, and GDP expansion in new economic giants, such as, Brazil has ground to a halt. The strong relative performance of the U.S. economy bodes well for U.S. stocks.
Second, the "Arab Spring" is becoming the "Global Spring." This is not about a "mission accomplished" moment for U.S. foreign policy. It's more about the rising power of a global middle class that wants to pursue its hard won economic freedoms. The people you see protesting in Moscow and elsewhere are not angry young men. They are Google (GOOG) and Price Waterhouse employees who have had enough of anachronistic political systems. Even as these members of the new global middle class take to the streets, they convert their money into U.S. dollars and buy U.S assets. When push comes to shove, the U.S. remains the ultimate safe haven during times of uncertainty, which is bullish for everything from U.S. dollars to Miami real estate to U.S. stocks.
The Chinese Economy Will Continue Its Slow-Motion Train Wreck
Many Chinese banks and local governments are already bankrupt. The Chinese real estate bubble is popping, as empty cities, malls and thousands of government-financed "bridges to nowhere" become monuments to the greatest financial bubble in global economic history. While some pundits continue to be enamored by Shanghai's skyline, the market is slowly catching on as Chinese shares hit a 33-month low.
Having studied the Soviet economy in the "bad old days," I've been a big China bear for a long time. Yes, differences exist between the Chinese and Soviet economic models. In the 1950s and 1960s, Kmart wasn't chock full of cheap Soviet goods that helped finance a Soviet economy that was predicted to overtake the U.S. by 1984. At the same time, the misallocation of resources, widespread corruption and distorted economic targets in a "soft budget constraint economy" governed by a Communist party make the Soviet and Chinese economies more similar than different.
On a microeconomic level, Chinese state-owned enterprises lessen value in the same way their Soviet counterparts did. On a macroeconomic level, the suppression of consumption in favor of investment as a way to boost headline GDP in China has led to economic distortions unmatched even in Soviet Russia. Add in China's real estate bubble and its looming banking crisis and you have the ingredients for an economic collapse that will make the U.S housing bubble seem like a rounding error. China's implosion will mark the end of the current leg of the commodity super cycle as much of the demand responsible for driving commodities prices higher for more than a decade will have evaporated.
And that's just the economics. Growing political instability -- with tens of thousands of anti-government demonstrations every year throughout all of China -- makes the country a political powder keg.
The Euro May Break Up
Despite the numerous EU summits to the contrary, the possibility of the euro breaking up in 2012 is real. If that day comes, it will be much like September 16, 1992, the day George Soros made a $1 billion betting against the British pound. That day, the British Pound Sterling collapsed, as the U.K exited the European Exchange Rate Mechanism that had linked the value of the British currency to the nascent euro.
Hedge funds that are short the day of the euro's collapse will profit handsomely from their own "George Soros moment."
Recommendation: Buy January 2013 $20 call options on the ProShares UltraShort Euro (EUO).