Important Trends for 2012

by Wayne Ferbert on December 28th, 2011

In developing our investment approach, we usually start with a macro view and let that drive nearly all of our investment decisions. We refine the macro view and keep asking ourselves this question: “what outcomes are likely given our macro point of view?” Eventually, these outcomes lead us to direct and specific investments we can make that will be impacted in some way by the macro view.

And we go through this process all year long – constantly questioning our macro views, our assumptions, and our predicted outcomes. It is not a once a year process. But with all of the year-end articles that make predictions for 2012, you would think this is the only time money managers and financial pundits ask these questions.

But I thought I would go with the flow a little bit and discuss some of our macro views here – since it seems to be the time of year to write such a posting. So, here goes:

1. We already wrote last week about our view on mid-cap growth stocks (click here to read that).

The summary view is: mid-cap companies have enjoyed access to capital markets in the last 3 years while small caps have not. So, these mid-cap firms have been able to invest in their businesses – and those investments will likely pay off in market share gains in next 1-2 years.

2. The gridlock in Washington will continue to make CEOs reticent to make large capital investments.

The uncertainty over the election and the mandate for change that WILL come with it continues to haunt the businesses that rely on enterprise spending – especially the larger capital investments. This means that the industrial and manufacturing and transport companies that rely on large enterprise capital investments will be hurt the most. Even the manufacturing and industrial firms that build direct to consumer products will be reticent to make new investments with the political uncertainty – which means these firms may slow their product re-fresh and slow their productivity gains. This lack of capital spending inside these industries just continues the on-going trend – which has made these sectors under-performers.

I think the 2nd half of 2012 will be big for these industries. Some investors may start to put money to work in these sectors if they continue to under-perform – hoping to be early to an eventual recovery. It will be important to watch the election, consumer sentiment/confidence, and many key economic indicators in the 2nd half of 2012 to see if a recovery is imminent in these areas.

3. Tax reform will be a HUGE policy hot-button in the election in 2012 – but the actual tax reform won’t come until 2013 at the earliest.

One thing we know for sure: Herman Cain and Ron Paul have both touched a nerve with their ideas on tax reform. Tax reform will pick up momentum – and it will be part of the mandate of the winner of the Presidential election. The only conundrum: Obama’s tax reform and the Republican tax reform are guaranteed to be very different when implemented. If Obama stays in office, expect the tax code to become even more progressive.

No matter which party wins, I think you can expect a simpler tax code – one that implements some form of flat tax or consumption tax increase. In making the tax code simpler, you’d have to expect many tax deductions to be limited or eliminated. The only way to really make an impact on tax revenues and make the tax code simpler would be to tackle the really BIG deductions: capital gains, mortgage deductions, medical deductions, & charitable deductions. Needless to say, the lobbies that back these tax deductions are not shrinking violets. They will fight to protect these deductions. Expect a rocky road as we march towards tax reform.

4. Technology is entering its 2nd renaissance – and it will be led by Software.

Don’t let the recent head-fake by Oracle’s earnings throw you off. Enterprise spending on software will not be weak for very long – if at all. Software continues to change our lives more than any other trend ever has. And the proliferation of mobile devices has made our access to software even easier. Most industry executives when polled still believe they have only scratched the surface of productivity gains that can be had from software. Also, the barriers to entry in the software space are low – meaning innovation can come from almost any basement in any country.

But the trend that trumps all is the move to the cloud. The move to the cloud will produce many gains. But it is a trend that will have impacts for at least a decade. Outsourced software still has a lot of room to grow. Only 10% of the revenue in the software industry comes from software hosted thru the Internet. There is no way that number will still be that low in 10 years.

But the low barrier to entry makes predicting the winners a little harder than it used to be. You’ll need to do your research to target the winners in this space. But don’t be mistaken – a talented software developer is worth his weight in gold – and the industry will spend the next 10 years proving that to be true.

One thing I know for certain – 2012 will be an interesting year. But unlike most pundits, we’ll constantly re-visit these macro views and update them.

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