Principal's Corner

2012 Outlook

Yu-Dee Chang, January 2012

2011 was an interesting year, filled with surprises, uncertainties and volatility in the economy and markets.  Below I have  outlined what I believe are five possible outcomes for the global economy and for markets in 2012.

1. GLOBAL POLICY EASES

The United States continues to recover. The European Central Bank (ECB) lends to sovereigns through very cheap long-term lending to the banks and eases policy sharply. China eases monetary and fiscal policy early and sharply. Global growth still slows but it is less sharp.

2. A GLOBAL MUDDLE THROUGH, BUT MARKETS BECOME INCREASINGLY CONFIDENT ABOUT POLICY

US holds off on fiscal tightening and further bouts of quantitative easing (QE). Markets become increasingly impressed with the resolve of European Union institutions and countries to stabilize. Global growth slows, but it is less sharp.

3. A EUROPEAN MUDDLE THROUGH, BUT MARKETS REMAIN UNIMPRESSED BY POLICY

Fiscal policy is tightened pretty much across the board in the developed world. With the fragmented and misguided efforts by European politicians, markets continue to fret about European defaults. China and other emerging countries continue to keep policy tighter than expected. Global growth slows sharply.

4. SELECTED EUROPEAN DEFAULTS, GLOBAL CONTAGION

There is an actual default, or even more than one, within the Euro. Here, contagion spreads fast and confidence is shattered globally. Chinese policymakers perform a quick volte face thanks to rapidly diminishing exports, but to no avail. The world has a recession.

5. A EURO BREAK-UP AND GLOBAL DEPRESSION

A break-up of the Euro and widespread default occurs. The world has a recession bad enough to call it a depression.

I believe there is a higher likelihood the outcome of these scenarios will be skewed toward the downside. This is not only because we expect the global economy to continue to weaken; it is also because the results of a very nasty outcome are worse than the results of a nice outcome are good. We caution for now. If these risks do materialize, I think it will lead to investment opportunities that could be much more attractive than they are currently.

From an equity perspective I think parts of Europe are already very cheap, even considering our very conservative cyclically adjusted valuation metrics. Given the size of the Eurozone and its debts, it would be very surprising indeed if valuations elsewhere did not also fall. At the same time, I believe we could stick to companies with sustainable and high dividends and stable market shares. We could also continue to pay attention to (1) US non-financial, long-dated investment grade corporate debt, (2) to a lesser extent, longer-dated US Treasuries, and (3) short-term investments in technology stocks, energy stocks, and precious metals.

I cannot over-emphasize the importance of asset allocation and diversifying into alternative investments under this 2012 macroeconomic and investing environment. I do believe as we progress through the year alternative investments and strategies with no correlation to the stock market will gain increased visibility.

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Looking forward to a Healthy and Wealthy 2012.

Yu-Dee Chang

Founder and President

Chesapeake Investment Services, Inc.

This communication is not a recommendation or a solicitation to trade. There is substantial risk of loss in futures and options trading and is not suitable for all investors. There are no guarantees of profit no matter who is managing your money. Past performance is not necessarily indicative of future results. Investors should consult their own financial advisor before implementing any idea or strategy derived from this communication.