The Script for 2012 - And Your Part In It

Welcome to 2012, the third act of a tragic play. As an investor, you have a part in it.

So, if you haven't been paying attention to character development or lost sight of the plot, you're going to be frozen onstage when it's your turn to act.

Here's your script and some direction.

The set-up went like this: The audience walked into the world theater in September 2008. They took their seats and read the card left on their velvet chairs. It was short. It said:

Act I opens with the backdrop of mounting tension as insanely leveraged homeowners, consumers and banks scramble to make sense of declining home prices. The curtain lifted and the show began. The first act was dramatic, but ended in March 2009.

Act II began immediately without an intermission. Asset prices began to climb from their depths thanks to massive global stimulus.

But, Act II also revealed the tragic nature of this play. In spite of "green shoots" and rising commodity and stock prices promising a return to normalcy, the truth is that the world changed before the credit crisis and the Great Recession. There's a "new normal."

Globalization has increased labor pools, lowering costs and causing massive shifts in manufacturing realities, while productivity gains orphaned an army of white collar, middle-management sergeants, mostly in the developed world.

Seismic shifts in emerging markets were met with inflows of capital, while in developed countries, especially Europe and the United States, outflows of capital were offset by politicians borrowing more from future generations to promise retirees they would be able to retire.

As Act II comes to a conclusion at the end of this year, and Act III is going to look completely different. In fact, it might be titled...

"The Hangover."

That's what 2012 is going to feel like - a bad hangover.

There are fewer workers working in America today than there were in March 2000. One reason is that there are 6.6 million fewer jobs in the U.S. today than there were just four years ago.

Some 23 million people want to work full time, but can't find a job. Half of the unemployed in America are long-term unemployed, meaning they've been out of work for more than a year.

Not only is it hard to find jobs, most of the unemployed don't have the skills to fill the jobs that are out there. And, structurally, the mobility of workers in America has crumbled as homeowners can't sell their houses to move to where jobs are or might be. Need I mention that rents are rising too?

Average household income in the U.S. is less than 1% greater than it was back in 1989, according to the U.S. Federal Reserve. And over the past six years, household net worth relative to disposable income is lower by 20% as a result of overleveraged and declining home values.

MM Outlook 2012
Meanwhile, more than 2 billion workers from Asian and Eastern European countries have joined the global labor pool.

While on the surface, a larger labor force may be good for producers, at the other end of the supply chain, lower wages mean less purchasing power on an aggregate basis.

It's not inflation that we have to worry about, it's the continuing deleveraging of households and countries, and the threat of deflation that will make 2012 a sad act to follow.

The stimulus in the U.S. and in Europe that was gifted to banks in the hopes that they would spread the wealth has been an abject failure.

Asset prices, including commodities, rose as excess liquidity remained in speculators' hands instead of being funneled into long-term investment projects to rebuild crumbling infrastructure.

Now, with budget-busting deficits and massive long-term structural debts, we are being led by combative politicians to the wishing well of productive spending and being told there is no more water in the well.

If our collective thirst for productive long-term investment - okay, call it stimulus spending - is not slaked, we will dehydrate our economy and cause another dust bowl, only this one will be worse than the Great Depression.

So, how are you going to act?

It would be wise to continue to be defensive - that is, until Act III seems to be coming to an end, which may be possible by the end of the third or the beginning of the fourth quarter of 2012.

If deleveraging continues -- and you'll know if that changes (watch for any significant and sustainable uptick in inflation) -- then commodities and risk assets should stay on the shelf.

There'll be plenty of time to go shopping for risk-on assets, especially commodities. If by the first quarter of 2012 there is no resolution to Europe's debt issues, and if China continues to slow, risk-on assets will be shed with increasing speed and volatility.

I like big-capitalization, high-dividend paying (preferably 4% to 5%, or more) stocks of companies sitting on huge capital reserves and NOT spending them on buybacks.

I like selling calls on these stocks and I like selling puts, too.

I want income from selling premium. If your appreciated stock gets called away, good, you're ringing the cash register. If the puts you sold cause you to have to buy more stock at a lower price, good, you are averaging down into great stocks whose dividend yields are only increasing (as long as they are not cutting payouts).

The way to act in this tragic environment is as if your most important role is preserving capital, because that's what's going to make you shine when there's a new play to act in.

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About the Author

Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.

The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.

Shah founded a second hedge fund in 1999, which he ran until 2003.

Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.

Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.

Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.

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