#2 What Didn't Work in 2012

by Wayne Ferbert on January 22nd, 2013

#2 – Speculating on Washington Politics
In our countdown of what worked/didn’t work in 2012, the #2 What Worked was Following the Fed. The Fed pumped money in to parts of the bond market driving interest rates lower. In turn, they drove the displaced investors in these assets in to riskier assets. So, the risk trade worked in 2012 – and the broad stock markets advanced as a result.
But in a year in which politics completely dominated the news cycles, we challenge you to find an obvious winning trade that was driven by any part of Washington, DC – other than the FED! 
Let’s start with the biggest political story of the year: the election! Barack Obama was the favorite throughout the process.  And, despite one poor opening debate, he never lost his favorite status. If you thought that Obama was going to win, what was the obvious investment to play?
Not healthcare, really. He already made his dent there in 2011. I suppose you could choose to short defense/aerospace related companies. But that would not have worked out that great. The category was up 11.5% for the year. If you shorted them right after the election, then you made a tidy gain in one week (down 6%), but the rebound right after that was strong. They are back up to near its 52-week high today. You would have needed to exit that trade right away. How good was your timing?
Or, you could have bet against Financials expecting the Obama administration to deliver on its rhetoric and come down hard with regulations on the Financial players. We already know from prior articles that Financials were the best performing sector in 2012. But let’s examine them since Obama won.
Financials, like defense/aerospace also lost 6% in the week after the election – similar to the decline in the broader markets. But since the markets bottomed the week after the election, Financials have been the biggest individual sector gainer. The sector is up 13% since that day.
We wrote in this blog that we thought that Obama was all bark and no bite when it comes to financials reform. But if you take the candidates at their word and invest according to their platform, then you would not have had a pleasant investing experience in 2012.
Of course, making any investments that bet on the other horse winning might have made you money – but it wouldn’t be for the right reasons, would it? A Romney win would have theoretically been a boon for Defense/Aerospace and the Financials. So, if you went long those sectors expecting a Romney win, then your investments probably paid off. But then that was just luck since your investment premise of a Romney win was wrong. Right? Of course, after Obama won, did you sell the Defense and Financials positions in to the weakness that week? Or hold on and reap the gains since the week after? They were down 6% in a week! Did you have the stomach to hold on and reap the big gains since? Not likely.
I’ll tell you, investing based on what you think is going to happen in Washington in 2012 was like banging your head against the wall. Take another example: the Fiscal Cliff at year end. This story was so broadly reported on that you would have thought that it involved a real cliff with people jumping off of it!
The pundits said over and over again that a real fiscal solution would send the markets in to a strong rally. If Congress and the President could agree on the tax increases, spending increases, and debt limit, then the markets should take that as a good sign. Indeed, if the solution was structured so that these parties wouldn’t square off again on these issues for at least another year, then the markets should rally even more.
Every day in late November and all thru December, new rumors swirled and the rumors drove the markets. But buying and selling on these rumors was no guarantee that you would make money. Ultimately, no real solution was found. They agreed on tax changes in a range that was expected by the market and no real spending solution was found. Now, the budget process is right around the corner and we are up against the debt limit deadlines.
Yet, the market is in a little mini-rally since the January 1st compromise! The markets bottom in December was around December 28th when the compromise looked bleakest. And here we are in a 6% rally since that date. There was really very little to get excited about in this compromise from a real process perspective. Yet the markets have rallied.
The investments to make were not obvious. You can’t look back on 2012 and believe that Washington really accomplished anything substantive. Yet, if you went long betting that they would help the markets, you would have made money. But you need to have perspective: you made money because the markets went up. Washington had very little to do with it. The Fed and improving earnings drove the markets up.
And if you invested by shorting the market expecting Washington to screw up, then I hope you feel some solace from being right about Washington. But solace won’t replace the funds in your account. Being short the market on the premise that Washington would mess up the markets/economy would not have worked either.
It was just too difficult to connect the dots between an investment hypothesis based on Washington DC politics – and an actual investment outcome. In the end, ignoring the noise from Washington was a good investment move in 2012.

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