The markets finished 2011 with some momentum and, for the first several weeks of January that momentum fed into 2012.  The markets seem to have begun the year with a sense of relief, almost as if to say, “It simply feels better now that we’re not in 2011”. While it is not based on empirical data, market participants are almost giddy to start the New Year.

There remain a myriad of positives and negatives in this economy, which is why we saw no real headway made last year.  The European debt crisis continues to be the most negative headwind we are presently facing.  As of this writing, it appears they may have hammered out a deal to write down/swap much of the troubled Greek debt, which would have some positive ramifications for the Eurozone.  The problem is, we have seen this story before and the markets are very cautious to anticipate this.  On a positive note, the economy technically remains on reasonably solid footing.  Our channel checks point to an economy that grew 3+% in the fourth quarter and that, in perspective, is a good number.  Keep in
mind that we continue to believe what we’re seeing in our economy is more a “crisis of confidence” than a wealth problem.  Earnings remain strong and corporations are hoarding cash.  With the Eurozone issues and the political gridlock we’re experiencing, companies simply don’t have the confidence to go out and expand their businesses.  However, a change in confidence with markets can develop quickly and we believe that at some point in 2012 that could very well happen.

In looking at historical tea leaves, let me mention that we actually have a couple interesting tidbits working in our favor coming into 2012.  First, the fourth year of a presidential term typically has a positive bias in the markets.  Conventional thinking is that it is because investors feel the “ship will be righted” in the next four years.  Also, for whatever it is worth, but true nonetheless, years that end in “2” have historically shown outperformance.  Obviously, these types of  outperformance precedence aren’t set in stone.  But, it’s nice to know we may have a slight edge coming into this election year.

Frankly, many of the fundamentals of our economy are improving:

1. GDP growth appears to be accelerating with our  current channel checks coming in around 3.5% annualized.  If sustained at this level, it would be strong enough to create new jobs.  Obviously job growth is the primary driver to consistent economic growth.
2. Christmas sales have been remarkably strong, with online retail leading the way with a 7% increase year over year.  While consumers have continued to spend, the high numbers of unemployed consumers has kept a cap on the economy.

However, the other 2 negative factors which we must ultimately solve for sustained economic health are:

1. The European sovereign debt issue… a long-term solution must be forged out.  So far the crisis has been dealt with by applying various short-term band aids.
2. The U.S. debt issue… Our aggregate national debt has now reached 100% of our annual GDP this is a level we have not experienced since WWII.  Obviously, until there is a long-term political solution to this it will continue to plague our economy and thus our markets.

We would hope that the 2012 elections will provide some clarity for our economy and markets.  In the meantime, we will continue with vigilance to find niches of opportunity while exercising a cautions perspective.

On behalf of our entire team, I leave you this month with my most sincere best wishes for the 2012 New Year.

Notwithstanding…

The European Debt Crisis.

The failure of Congressional Super Committee.

No relief in sight for the US Housing Crisis.

Record high unemployment levels.

I am writing this letter today watching:

A stock market close for the day with an almost 500  point gain (Dow Industrial).

An economy still growing at a 2.0 – 2.25% GDP growth  rate.

Black Friday sales numbers which set new records.

The market continues to trade at the mercy of changing news out of Europe and in a US economy with no real accelerated growth.  However, at the “end of the day” as we approach the end of the year, it appears that the market will end with positive growth for 2011.

As we have discussed in the past, money always is “chasing” security and yield.  In spite of all the issues, there still is nowhere else in the world that better provides security and potential yields than the US.  Hence money continues to flow into the stock market driving it higher.

Except for unforeseen geo political circumstances, we cautiously expect this rally to continue through the end of the year and into early 2012.

As we enter into the Holiday Season, on behalf of our entire Delta team, Please accept our very best for a most joyous Christmas and prosperous New Year!

As I write this month’s letter, I am watching the market rise above the 12,000 (Dow Jones) mark.  This rally is a result of a European debt bailout by the European Union, the international monetary fund, and of all people, China.  In fact, the market is on course for the largest monthly point gain in the history of the Dow Jones Industrial Average.

That said, what does all this mean to us as asset managers?  That question is perhaps best answered in an assessment of both short and long term perspectives:

On the short term:

The need for a European bailout was the result of major sovereign debt issues across the continent.  The default issues started with Greece, but the bigger fear was that a Greek default would spread to countries like Italy, Spain and Portugal.  None of these countries individually is a major driver, but the ripple effect could be devastating.

This current market rally, while well received, may also be an oversold bounce before we go lower, so we’re being patient in this area.  It’s not that we don’t appreciate the rally; we simply need more evidence it’s sustainable.

We are still not seeing consistent job creation.  Of course, this continues to be the primary catalyst for full recovery.  As discussed in last month’s letter the primary reason for lack of job creation is lack of confidence in the political direction of our country.

On the long term:

Corporate earnings are good and corporations are flush with high amounts of cash.

Consumers have much stronger balance sheets than in recent times.

While consumers have retrenched and become more fiscally responsible, their spending continues to keep our economy afloat.  They have, however, curtailed spending on luxury goods, autos and housing.

Even at the panic lows of 1998, stocks were about twice as expensive as they are now.  The markets are at very reasonable long term valuations, which should eventually be a strong catalyst for growth.

On a personal note…  We as Americans have the great privilege and freedom of celebrating in a few weeks, The Feast of Thanksgiving Day.  On behalf of our entire Delta Team, please accept my very best wishes for a day filled with thankfulness.

In the past hour while writing this letter, the Fed announced the implementation of another monetary strategy in an attempt to inject more cash into the economy.

Of course, the stated objective is to “spur economic growth”.  But, the operative question is: “Do we have a ‘money’ problem or something else?”  It is our belief that it is not a “money” problem plaguing us, but rather a “confidence” problem.

There are, of course, many factors which lead us to such a conclusion…to look at a few:

The markets continue to essentially churn sideways with no real confidence.

Over the past several months, the economic data has been very mixed giving us no real foundation for growth.

Large amounts of money flowing into treasuries, thus driving down yields.  In fact, the 10-year bond closed today at its lowest level ever.

The markets are trading at very low equity valuations and dividend yields are very high compared to historic levels.  Thus, we are seeing substantial long-term value but not real catalyst to attract buyers and thus drive the markets to higher levels.

Now…interestingly, corporate insiders have continued to buy up their own stock.  But… these insiders are typically early and are looking long-term.  We continue to agree with these insiders that the long-term economy capital markets have substantial potential.  But, the short-term is a bit cloudier.

As always, we continue to look for emerging trends and sectors which have potential upside growth.  At the end of the day we still have a 14 plus trillion dollar economy.  And… that’s a lot of commerce and potential opportunity for investors.

We think there are a lot of comparisons between the summer of 2010 and 2011.  First, we see the same array of indicators lining up now as we saw a year ago.  Does that mean we will experience the same 4^th quarter results as 2010?  Obviously, we will not know that answer until early 2012, but there are a lot of “under the surface” positives that people are simply choosing not to see.

As we have often said, ultimately at the end of the day, markets are driven by one thing and that is corporate earnings.  At closer glance, we see many positives on the earnings front:

1. Second quarter earnings reports were very strong but, maybe more importantly, most companies have continued to hold their guidance.  That translates into the fact that these companies believe they can hit their 3^rd quarter projected earnings.

2. Corporate insiders have been buying a “ton” of their company’s stock.  The reason is obvious; they believe they can make money buying their own stock at these levels.

3. Additionally, most leading economic indicators are still pointing to positive growth for the remainder of 2011.

History tells us that, when markets suffer a shock and the technical picture is broken, time is needed for them to heal.  So while we fully expect to see more choppy waters in the short-term, we believe that a strong run by year end is
forthcoming.

In a worst case scenario, we “could” see ratings agencies such as Moody’s, S&P and Fitch downgrade U.S. debt.  Such downgrades would possibly be more damaging than the default itself as it would likely force increased selling pressure on all forms of U.S. debt, leading to higher interest rates and lower bond prices.  Additionally, because we’re in a slow economic recovery rising interest rates would slow our recovery further, as borrowing costs would go up for companies and individuals.

History does not give us many comparisons for our current dilemma.  But, it is worth remembering that we experienced government shutdowns in late 1995 and early 1996.  In those instances, the stock market performed quite will.   In fact, the Dow Jones was trading around 3800 in November 1994 and around 4900 at the time of shutdowns.

What we need to focus on is that the markets are a “discounting mechanism”.  In other words, much of the fear of a shutdown was already “baked into the cake” in 1995 as the markets had anticipated a shutdown and adjusted/discounted  accordingly.  Of course, the prior results do not guarantee a positive outcome, but it does serve as a helpful antidote.  What the markets cannot discount are occurrences and events which are truly unexpected and unanticipated.  The markets know this issue is looming and arguably, investors have already discounted accordingly.  Case in point, the S&P 500 is currently off about 5% from its highs and the markets have essentially gone sideways since January.  This is against a backdrop of improving corporate earnings, with much of this scenario is already built into the markets.

At the end of the day, the capital markets are signaling that America will not default on its obligations.  While our current situation itself is disconcerting, it should not have a very long lasting effect because corporate earnings, not politics, drive the capital markets.

Money is always looking for perceived opportunity and value.  While the U.S. economy has certainly slowed and faces headwinds, the commerce of the United States still leads the world in perceived opportunity and value.

Consider:

In May the U.S. added only 54,000 new jobs.  It was  some 100,000 fewer than the 150,000 expected.  But we did not lose 150,000 jobs and we are not expecting to lose another 150,000 or 200,000 this month.  Even at this slow pace in January 2012, 1.5 million people who were unemployed in January 2011 will have jobs.  This means higher consumer spending and  higher demand for housing.

Housing continues to be soft.  But, with that weakness, it is by definition a much smaller percentage of GDP.  So, the drag to future GDP growth, even with persistent weak housing, will not be as much of a negative impact as it was in 2008 and 2009.

As monies continue to chase perceived opportunity, those monies will invariably flow into the markets.  Even though as redicted, the market has recently flattened out, we expect to see a higher market by the end of 2011, and thus end the year with some nice gains.

Additionally, we believe one of the sectors that offers a lot of value from these levels is the financial services group.  We have begun to build positions in the group and feel that this is a space that can make us strong long-term profits.  Our desire is to build our positions over a few months to relieve any short-term market volatility.  We are positive on this sector for several reasons:

 Financial services companies are most profitable when we are experiencing a steep yield curve, as we are today.  Interest rates are very low, from a historical standpoint, but the spread between short rates and long rates is wide.  Remember, banks borrow short and lend long and low rates give these companies a quasi-free source of capital. 

About 40% of the S&P 500 is comprised of companies that work in a financial services capacity.  We find it hard to believe the markets will do well without this sector participating.  Our bet is they will begin to lead. 

Banks and financial services companies are once again loaning, which is a huge positive.  In fact, the Federal Reserve recently made note of this in one of their meetings. 

 In the end, we are probably a bit “early to the party” in our financial services investments.  However, as we have seen with other groups like gold, the lion’s share of the gains are typically made by being early, not late.

 This event has several implications. First and foremost, it should send a message to all our elected leaders that the days of politics as usual must come to an end.  While there seems to be almost universal acknowledgement of the unsustainability of deficit spending and runaway national debt, little is being done to rein it in.  Such behavior is obviously disconcerting.  As citizens and patriotic Americans, we must all insist that in order for a candidate to get our vote, there must be a real commitment to serious fiscal reforms.

The market’s reaction to the news resulted in a hard selloff.  Ironically, history has shown us that, while both the equity and debt markets experience selling pressure with such news, the equity markets substantially underperform the debt markets. It seems a bit odd in that the potential downgrade is coming from the debt side, but such is life in the capital markets. 

The current market correction will most likely last somewhat longer than it would have without such news.  In the short-term, we seem to be falling under the guise of the adage “buy the rumor, sell the news”.  In other words, the markets had a nice run up to start the year in expectation (rumor) of good earnings reports.  With the news being reported, the markets are correcting (selling), with profits being taken.

It is our intent to take advantage of this corrective phase depending on the level of the correction.  We continue to believe the markets will finish 2011 with positive returns.  The main caveat to that is, however, the price of energy.  As investors have flocked to buy energy, it has obviously driven up the price of oil.  If prices continue to raise much above the $110 a barrel level, it will hurt the consumer, slow the economy and create a less attractive stock market.