Goldman Sachs Top Trades for 2012

Goldman Sachs released their top picks recently. While they didn't do so hot in 2011, their 2010 trades were more fruitful. Here is what they think for 2012:


1. Short European High Yield credit (Buying protection on the iTraxx Crossover index), for a target of 950bp (opened at 770bp) and a potential return of 4.5%, stop at 680bp

2. Short 10-yr German Bunds for a target of 2.8% (open at 2.3%) and a potential return of +4.5%, stop 2.0%

3. Go long EUR/CHF for a target of 1.35 (opened at roughly 1.2260) and a potential return of 11% including carry, stop at 1.20

4. Long Canadian equities (S&P TSX) vs Japanese equities (Nikkei), FX unhedged for a target of 120 (opened at 100) and a potential return of 20%, stop at 90

5. Long a Global Rebalancing Basket (CNY, MYR versus GBP, USD) for a target of 107 (opened at 100) and a potential return of 7%, stop at 98

6. Long July 2012 ICE Brent Crude Oil futures for a target of $120/bbl (opened at $107/bbl) and a potential return of 12%, stop at $100/bbl

Source: Zero Hedge

Structural Unemployment

14 million Americans are unemployed and yet one sector can't hire new employees fast enough. Looking at the charts below, it is plain to see that manufacturing job vacancies in the United States aren't being filled to meet demand. In fact, the October 2011 unemployment rate for manufacturing was 7.7% compared to the overall unemployment rate of 9.0% (per the Department of Labor).

Consider this, on average it takes companies about 7 weeks to fill a vacant job. Recently, hiring a new manufacturing employee has taken approximately 12 - 15 weeks.

This data supports the notion that there is structural unemployment in our economy, where American skills and American jobs are mismatched. High unemployment rates aside, think of the lost production / GDP / consumption our economy is missing out on.

Fixing structural unemployment will take time. Troops returning home will have solid military training, which may translate well into the manufacturing workplace, but that alone is not the solution. Americans will either have to outsource a segment of this supply chain or place a larger emphasis on trade skills in our educational system.

One thing is certain: manufacturing is fueling much of our economy's current growth. We need to support the strength of this sector.

This graph illustrates how job openings in the manufacturing sector have outpaced total nonfarm job openings from the depths of the recession.

Sources:
stlouisfed.org
cleveland.com

October Industrial Production Beats Estimates

Industrial production expanded by 0.7% in October, beating analyst estimates of 0.4%. However, the reading for September, initially reported at .2%, was revised down to -.1%. That being said, actual two month industrial production is right in line with analyst estimates. The graph below demonstrates how this sector continues to be a source of support for our recuperating economy.

 Specifically, this production data measures the total output of manufacturing, mining, electric and gas industries in the United States. At current levels, industrial production is still 5.3% below pre-recession levels.

The Federal Reserve published a nice breakdown of the industry groups that contribute to industrial production:

"Manufacturing output increased 0.5 percent in October and was 4.1 percent above its year-earlier level. In October, the factory operating rate moved up to 75.4 percent, a rate 11.0 percentage points above its trough in June 2009 but still 3.6 percentage points below its long-run average.
The output of durable goods increased 0.8 percent in October and has gained 7.8 percent in the past 12 months. Advances of at least 2 percent were reported in October for electrical equipment, appliances, and components; motor vehicles and parts; and aerospace and miscellaneous transportation equipment. In contrast, losses of 2 percent or more occurred for wood products and nonmetallic mineral products.


The index for nondurable manufacturing rose 0.2 percent in October. Among the major components of nondurables, the output of apparel and leather jumped 2.8 percent, and gains were also registered for food, beverage, and tobacco products; chemicals; and plastics and rubber products. Decreases were recorded for textile and product mills, paper, printing, and petroleum and coal products. The index for other manufacturing (non-NAICS), which consists of publishing and logging, declined 0.2 percent.


The output of mines climbed 2.3 percent in October, with gains in each of its major components, after having dipped 0.5 percent in September. Capacity utilization in mining moved up to 92.7 percent in October, a rate 5.3 percentage points above its long-run average. The output of utilities edged down 0.1 percent, and its operating rate declined to 77.5 percent, a rate 9.1 percentage points below its long-run average.


Capacity utilization rates in October at industries by stage of process were as follows: At the crude stage, utilization increased 1.5 percentage points to 89.9 percent, a rate 3.5 percentage points above its long-run average; at the primary and semifinished stages, utilization edged down 0.1 percentage point to 74.0 percent, a rate 7.3 percentage points below its long-run average; and at the finished stage, utilization rose 0.7 percentage point to 77.2 percent, a rate 0.1 percentage point below its long-run average."

Source: Federalreserve.gov

Trouble in the Euro-zone

This is a great illustration from Mint showing Euro-zone public debt as a percentage of GDP. You can easily see why the PIIGS are in trouble.

Q3 GDP Revision

This morning, the revised Q3 GDP (Gross Domestic Product) data was released. After revisiting the numbers, the Commerce Department lowered their initial growth estimate of 2.5 % down to an even 2%.

In economic theory, Okun's law describes the relationship between quarterly changes in GDP growth and quarterly changes in the unemployment rate. Generally speaking, reduction in the unemployment rate trails GDP growth by about 2%. Therefore, with the current economy displaying anemic growth of 2%, the unemployment rate will remain at 9% for the near term.

After digesting this information, the stock markets opened modestly lower.

Source: TaintedAlpha.com


Following a GDP growth reading of 1.3% for the second quarter, growth of 2.5% would have been a large jump.

What is Quantitative Easing?

Quantitative easing is a government monetary policy used to inject liquidity and increased lending into the system by expanding the federal balance sheet. The Federal Reserve will typically purchase government securities, thereby increasing the supply of dollars in the market. Their hope is that this will increase consumer spending and stimulate the sluggish economy.

During this unconventional process, the Fed walks a fine line of fueling the economy and creating inflation. However, with rates close to zero, this is usually not a problem.

Another result of quantitative easing is the devaluation of the currency. Because the money supply is now larger, each dollar is worth slightly less. This directly impacts the country's imports and exports in the following way: those who import goods are harmed by a weaker dollar and exporters benefit by increased demand for their less expensive goods.

Dollar Cost Averaging

One of the first-taught mantras of investing is to buy low and sell high. In doing so, an investor can realize the greatest appreciation from their purchases. The problem is that it is impossible to accurately and consistently identify market troughs and peaks. So, this begs the question: how can one most efficiently deploy their funds into the market?

Clearly there is no fail-safe method, but utilizing a system of dollar cost averaging can help investors achieve more stable prices by reducing sensitivity to the timeliness of trades.

BusinessDictionary.com defines dollar cost averaging in the following way:

"An investment strategy that seeks to minimize risk by reducing the average cost per share. Under this plan, an investor invests only a fixed amount in securities at regular intervals, regardless of the market's up or down movements."

Chances are, you already facilitate this strategy without knowing it. If you are employed have money consistently taken out of your paycheck that is automatically invested, you are dollar cost averaging.

Rather than trying to time market fluctuations, dollar cost averaging helps investors stabilize their investment's cost basis. In practice, your identical contributions will purchase less of a security when the price is high and more of the security when the price is low. Therefore, you can achieve a lower average cost for your purchases over the long-term.

Here is a nice illustration from FinanceEditor.com:

Hedging

Hedging is an important investment strategy employed to reduce risk in one’s portfolio by spreading out the risk of loss between multiple assets. Think of hedging as an insurance policy for your investment. The theory is that when asset A experiences volatility, asset B may perform well enough to offset a portion of your loss.

Many savvy investors use futures contracts, options or short positions to protect their underlying asset. Another common hedging practice is to allocate a portion of your funds to high yielding financial instruments, commodities, or real estate to combat the effects of rising inflation.