It’ll be a quick newsletter this week.

We’ve got some cool things on the docket for the next month or two.  I’ll be releasing some special, focused articles, some of which should hopefully start popping up in other magazines and websites.  I’ll be doing a big update on real estate, which always seems to generate a lot of reader engagement.  I also hope to have another interview or two this quarter with some colorful and fascinating individuals.  I’m really excited about this stuff and I think you guys will enjoy it.

In the meantime, to supplement today’s relatively (thankfully?) meager offerings, check out a more in-depth piece I wrote for Seeking Alpha about some things investors should look at if they’re interested in natural gas.

Where’d the Vol. go?

Volatility continues to leak out of the marketplace.

We talked about this a month ago, just after the ECB announced that it would lend over $600 billion.  This is what I wrote at the time:

I’m cautiously optimistic that the period of being forced to guess and trade around the European news headlines is behind us.  Barring additional whammies that pop up out of nowhere, I’d expect a period of generally lower volatility in the weeks and months to come.

For what it’s worth, I’m still cautiously optimistic about this period of generally lower volatility hanging around for a little while longer.  If you’ll recall, at the time the market was really freaked out about a banking crisis over there.  That risk has clearly subsided.

This week we also saw the IMF boost its lending capacity by another half a trillion dollars.  Isn’t it funny how casually we use terms like “half a trillion dollars” these days?  This is all part of the strategy of establishing “firewalls” to prevent it from devolving into a panic-driven banking crisis.

Banking crises are the really scary things.  Markets can cope with recessions and earnings misses and one-off bankruptcies.  But they can’t handle full blown systemic panics.  That’s when everything goes down, when people starting pulling as much cash as they can out of ATMs, and investors sell indiscriminantly, unsure which companies are solvent and which are not.  It’s past the point where standard and even non-standard policy measures have any effect.  Crises like these are where worst-case fundamentals intersect with worst-case pyschology and create a negative feedback loop with long-lasting costs.

But the ECB seems to have found religion.  Industry scuttle suggests that they’ll also be cutting rates at a future meeting.  I don’t know how much of a tangible effect an extra 50 basis points will make.  But the point is that it’s an indication that they’ve gotten with the program.

It’s a huge mess over there.  It’s going to be messy for a long, long time.  Nobody knows exactly where the pieces will wind up in the endgame.

I think the appropriate investor response is caution.  It is possible to formulate a good long-term strategy.  It involves owning the stuff that’ll still be standing strong a decade from now and avoiding the stuff that lives at the heart of all the fear and uncertainty.

If you own stocks with clean, transparent balance sheets, companies with powerful brands, and businesses in the sectors that will grow alongside GDP & population, you’ll probably be OK.  If you build out a diversified portfolio that also includes assets that generate cash flow and would benefit from a little inflation, you’ll probably be OK.

There’s a way that you can do even better, but it involves a substantial degree of skill.  Investors who know how to apply a medium-term tactical approach to their investing should be able to wring out a few additional points of excess return from the market.  It’s difficult, and it’s the type of thing that’s best done with the help of a financial professional, but it’s possible.  The tactical approach boils down to overweighting quality assets when they get abnormally cheap and lightening up towards a more conservative asset allocation when the market gets relatively frothy.  This is the kind of thing that some elite hedge funds do too.  It’s difficult and it takes skill, but there is plenty of evidence to suggest it works.

If I’ve said it once, I’ve said it a million times: the era passive investing and index strategies is over.  The next decade is all about relative value and getting more flexible with both your tactics and your strategies.

A Toddling Economy

Those of you who read the big 2012 forecast know that I am particularly bearish on the economy right now.  I think it’s going to be a really slow year.

There’s a lot of stimulus that’s coming out of the market right now.  Consumers are skittish about all the uncertainty in other parts the world as well as in our own backyard.  Nobody knows what policy is going to look like for the next 4 years, not with such a hotly contentious election looming.  Businesses are historically cautious with expansion and hiring, mostly because of plain ol’ weak demand, but also because of poor visibility on regulation and future taxes.

Unless the economy finds itself on clearly firmer footing a month from now, I do expect the payroll tax cut to get extended (again) since it’s such a political hot potato.  I know that temporary tax cuts and rebates are one of the most popular policy solutions to goose demand.  But this is where you clearly see what’s wrong with them.  At some point, they have to be taken away.

We simply cannot continue to have the Social Security withholding rate be 4.2% instead of 6.2%.  It was fun to put all that extra money into people’s pockets in 2010.  It moved the economic needle and, frankly, could have singlehandedly been the difference between recession and no recession last year.  But it was designed as a temporary package.  As permanent policy, it’s not just unsustainable, but ridiculously so.

So when do you reverse that?  How do you take something like that away?

Same thing with the 2001 Bush tax cuts.  Those were designed to be a temporary policy move as well.  But now that we’re at the point where they were supposed to run off, we are encountering massive difficulty rolling them back.  Some people groan and question if it would have been better if we’d never handed them out in the first place.  In retrospect, I think it’s now clear that there may have been some better ways to spend that money.

Regular readers know that I’ve got a toddler at home.  She’s almost 2.  Temporary policy doesn’t work with her.  If I give her a Dum-Dum and tell her, “you only get one and this is a one-time thing,” she eats it and comes right back for another one.  When I tell her, “No.  No more Dum-Dums,” she throws a tantrum.  It’s a good thing my role as father isn’t an elected position.  She would have thrown me out of office a long time ago!

Maybe it’s a little bit harsh to compare the psychology of the American economy to that of a 2-year old.  But it’s true in a lot of ways.

We got a pretty tasty Dum Dum in 2011 with the payroll tax cut.  The plan was to take it away in 2012.  But it doesn’t look like we’re going to be able to do it.  Nevermind the political ideology that always fogs up the debate about tax policy.  We actually have rational and fundamental reasons for handing out even more Dum Dums.  Taking them away will have a significant and quantifiable impact on the economy.  It could be the thing that tips us from being close to a recession to officially in one.  We’re on a Dum Dum diet!

Anyway, this payroll tax thing is a big deal.  Keep your eye on this and keep your eye on how Congress goes about addressing it.  I am certain it’ll get extended and equally certain that there will be plenty of political gamesmanship to go along with it.

Despite all this economic caution, I think there will be some good places to buy the market this year.  I’m relatively optimistic about the end of this year and into next — you know, as optimistic as one can get in a world where standards of living and consumer behavior have permanently changed for the worse.

Here’s that Natural Gas article if you’re hungry for more analysis.