Economic crystal ball: 2012

In general, we expect the world to be fighting a rising tide of economic challenges as 2012 unfolds. Many believe dysfunctional governments are becoming the norm on a worldwide scale. We don’t agree with this stance, but believe many are currently focusing on the symptoms of the financial services and banking structure disease, rather than the actual disease itself.

The world is looking for answers to two questions:

. What do we as a people expect?
. What are we willing to afford from our governmental systems?

We have written on these issues extensively in the past. Indeed our thematic piece from last year, “Black Swan Rising”, centered on this question. These questions are now front and center for not only U.S. investors, but also for investors globally. The question is being aggressively addressed not only in Washington D.C., but also in Berlin, Paris, London, Rome and, certainly, in Athens.

Let us move on to the more mundane issue of accounting, and the focus of much of the world: debt.

Late in 2007, we started writing and speaking on the issue, with our “Long, Hard Slog” theme. That theme morphed into the “Main Event” and the “Black Swan” themes. These economic and attendant investment thematic pieces all share one common denominator – that being the explosion of debt creation in both private and public sectors, which started in the U.S. in the mid-1980’s and continued until the economic meltdowns starting in late 2007.

Since inception, the theme has taken flight, and as outlined in detail in our “Black Swan” piece, Europe is now infected with the same virus – as are many segments of the continent. As Tom Laming, lead portfolio manager of Scout Small Cap Fund, puts it, they are “now running out of other people’s money to spend.” This is a very vivid and accurate way of portraying what is happening on a worldwide scale.

Over the period of time from 1985 to 2007, as the developed world was losing “market share” of the world’s income statement to more rapidly growing countries, debt creation was blossoming. A reasonable portion of that debt was being used to support ever-rising lifestyles.

In other words, the developed world’s balance sheet was being levered for current consumption purposes. Eventually, the party had to end – and end it has. The world’s capital markets have little if any tolerance currently for excessive leverage creation, except of course, in Washington, D.C. There, leverage creation continues and has been actually accelerating. Sooner or later this debt creation will end in Washington as it has elsewhere, in our view.

We are so certain of that statement, that it really isn’t a forecast – rather the forecast portion of that statement is only “when” will this end, and how painful will this be when the end actually takes place? We, as rational investors, all know this.
The other question is – will we as a people control this end, or will the markets control it for us? I hope, and believe, we as a people will control the end of this social experiment of excess leverage utilization.

Businesses and consumers by and large have made the decision to end these excesses. The peoples of the world’s developed economies now need to wrestle with this issue on a governmental basis. So, for those who live on other people’s money – we believe the times, they are “a-changing.”

If we are reasonably accurate on our diagnosis of our problems, then we can foresee how these problems may indeed end. Make no mistake, these problems will end – it is a matter of when and how, not if. As these problems end, or as importantly, as investors understand “how and when” these problems end – the world’s financial markets should turn sharply into bull market territory.

We believe we are some ways away from that turn occurring. However, we believe secular bear markets end and secular bull markets begin.
{pagebreak:Page 1}