I've been trying to be optimistic about 2012, which has required one thing -- avoid thinking about Europe.  It seems like we've been talking about Europe for two years now (oh wait, we have been) and frankly, I'm getting tired of it.  Those of us that believe Capitalism is the best model for economic prosperity knew that eventually Europe's Social Experiment would fail.  (Remember, Socialism works well until you run out of other people's money.)  I guess we should have all realized that they would do everything possible to delay the inevitable failure as long as possible.

Unfortunately, as we mentioned in our most recent Economic Update, 2012's theme is going to be US economic "strength" vs. European crisis.

They may not have a formal Quantitative Easing operation in effect, but the money supply is still increasing at a 15% annual rate, so they are obviously doing something.

This morning we are once again reminded that Europe's problems are not going away.  We are likely to see some mass sovereign debt ratings downgrades in the coming days, Fitch is reminding us that Europe is facing a 'cataclysmic' collapse, Germany's GDP dipped into negative territory, and Greece has once again failed to meet the agreed upon deficit targets (shocker).

One thing that we've been worried about is the unknown exposure to European debt by the Wall Street banks.  The biggest concern has been the Credit Default Swaps (insurance) that they sold on European debt.  When the latest bailout "deal" was announced for Greece, there was a "voluntary" 50% haircut on Greece's outstanding debt.  Meaning that all of the holders of the debt supposedly agreed to forgive half of the debt they were owed.  This is key because if it is voluntary, then it is not considered a default, so the sellers of the insurance do not have to pay up.  The issue we've been seeing is that many of the holders of the Greek debt are no longer willing to take the haircut.

This of course would trigger the 'cataclysmic' collapse of the EU as Greece would likely be forced (or leave voluntarily) out of the Euro, which would cause the European banks massive losses, which would then take away major funding sources for the other EU countries, which would cause more failures, etc, etc, etc.  Wall Street banks are lost somewhere in that death spiral, which would mean a drop in funding for US debt and problems in our own financial system.

So while the returns in the market so far in 2012 have been nice, the fear that Europe's problems could still derail our economy means that big institutions are unwilling to step up and make a commitment to the market.  That means volume once again remains anemic, which has left our systems just partially invested (35% stocks for EGA, 22% for EPA, and 35% high yield bonds for INA).

Like the Broncos, our game plan is to play the field position game.  Don't make any big mistakes and don't give up too much ground.  We simply want to stay in the game so that when the chance for a big play finally does present itself we are close enough to prevail.  It's certainly not fun to watch and can be very frustrating, but this conservative approach has served us well over the past 20 years and we are confident that our patience will once again be rewarded when the game is on the line.

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