Cop Logic for 2012

The book where I first read the phrase “Cop Logic” is lost to memory, but the concept stuck. A modern form of Occam’s Razor,  the process of cop logic states that when uncovering the violent death of a housewife in her home, and finding out that the ne’er do well husband is missing, it doesn’t make any sense to think up any scenarios beyond the husband’s guilt until he is found and questioned. Process must still be followed, but experience dictates a 95% probability the husband did it, and its best not to get distracted until that possibility is investigated.

I want to thank mining and energy analysts for so clearly supporting the application of cop logic to investing for 2012. For eight years, analysts in the resource sector have, correctly for much of the period, touted Chinese industrial demand for the “tree grows to the sky” supercycle in their sector. Over the past two weeks, however, Chinese demand as a catalyst for investment has all but disappeared in favor of potential supply disruption – geopolitical concerns in Libya and Iran for oil, labor disruptions in South America for copper. To see this as a bad sign we only have to remember what happens on Criminal Minds when the defendant is forced by new information to change their alibi.

Cop logic clearly implies slower global economic growth for 2012. It is entirely probable that the European Union may be saved by ECB intervention, but I would not hazard a guess on this either way. What is evident, however, is that even if the Eurozone is preserved, massive austerity for southern Europe will be a precondition for the rescue effort. For investors there appears only two potential outcomes – a horrendous structural implosion or a preservation strategy for the current system that all-but guarantees painful economic reforms and deep recessions for Italy, Spain, and other member nations.  Cop logic says rising GDP growth for Europe as a whole is simply not in the cards without divine intervention.

Trade data, while notoriously inaccurate*, indicate that the Eurozone and the U.S. are roughly equal in size as destinations for Chinese exports.  A significant decline in European economic activity clearly implies a headwind for 2012 Chinese economic growth. Economists will correctly point out that China’s economy is less export-driven than most believe, much more sensitive to infrastructure and real estate development. Unfortunately, as professor Chovanec details HERE, the Chinese real estate bubble us currently imploding, taking the balance sheets of a number of regional governments with it.

Cop logic also has implications for Q4 corporate capex although here there may be a silver lining. As Oracle’s recent results indicate, global CFOs responded to the potential for a European economic disaster by suspending capital expenditure. This only makes sense – investing in expansion is risky enough with a strong global backdrop. Earnings season for Q4 is likely to uncover a significant drop in corporate spending across the globe, which will affect revenues for large swaths of the S&P 500, most notably in technology, media and industrials. However, this trend could be temporary and stock sell-offs in these sectors could provide buying opportunities as conditions stabilize.

The sell-side bias towards optimism makes it easy to predict a wholesale attempt at obfuscation for 2012, giving us page after page of reasons why companies are likely to “side-step” a global economic slowdown. As we can see above, the process has already started for resource stocks as the bullish rationale adapts to a new economic reality. We will be given ample reason to invest further in cyclical stocks despite the fact that slower global growth almost by definition ends the possibility of relative outperformance. For this reason, cop logic will be instrumental for investors this year.

 

*It is one thing that Apple products are considered imports from China – they are assembled there – although the profit stays in Cupertino. But the calculation of the value of exports is archaic. Boxes of, for instance, Windows 7.0 OS disks, are valued at something like $20 per pound at the shipyard.

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11 thoughts on “Cop Logic for 2012

  1. Kris says:

    Sir,
    That’s why I’m short crude. Thx for confirming my commodities related thinking.

    Request: Could you write something about big banks: BAC, C, GS, JPM, MS? I think BAC will be restructured before mid 2012.

    One side note: Pls, DO NOT reveal your identity, ever. If you do, you’ll never write the same way again.

    • Interloper says:

      Thanks Kris. I don’t think anyone can sensibly value the banks until there’s more clarity on the balance sheets. It’s a risk vs uncertainty question for me. I also don’t love the write-ups on higher CDS costs on their debt. I am more optimistic than most seem to be on LTRO, but not enough to put money there yet. I’m actually researching euro telecoms.

      • Kris says:

        Sir
        You hit exactly what I expected. In a philosophical-behavioral-common sense point of view, if “no clarity of balance sheet” then people would run away as fast as they can leading to collapse of all of them. But no, there are still big funds like California Pensions, John Paulson, Dodge and Cox etc that own them. Of course, all big 5 own each-other’s shares. Taking a cue from Nietzche’s headline on your front page, are all these people insane as a group? It could be a good topic to write upon.

      • Mario says:

        first off great post. I completely agree with you. I use my parents and in-laws as gauges of what they want us to think….they have all been telling me that the US economy is looking up now and things are getting better, etc., etc. I expect 2012 to be “interesting” to say the least. Student loans appear to be the next venue for bubble-building…have you noticed that?

        I’m actually researching euro telecoms.

        are you looking at buying euro telecom corporate bonds by any chance? Like Telecom Italia in Italy? B/c if so then we are on the same page these days. If I may ask, do you go to any public sources for your research on such industries and if so where by chance? Or do you have paid-for subscriptions to things?

        thanks again and be well, etc.

  2. Interloper says:

    No. They’re not crazy. They are more concerned about tracking error than nominal returns. Mgrs would be fired for missing a rally, but not for following index lower if bank stocks fall.

    • Kris says:

      Wow. Interesting. To me, the 2nd sentence of your reply shows that the incentives system is insane, but not the people in the system that have to follow the guidelines and maintain their jobs (no pun intended to you personally).

  3. [...] How investors should apply “cop logic” to the investing world.  (Interloper) [...]

  4. Interloper says:

    Mario: so far, just using big house equity research, but I’m not in a hurry. So far, interested in Telefonica, but haven’t look at the debt structure in much detail yet.

  5. Kris says:

    Sir,
    This is very intriguing. My brain is experiencing some activity.
    You wrote before that you don’t believe in the existence of PPT, plunge protection team. However, in this post, you’re saying that the commodities traders are kind of “organized to mislead” which I totally agree.
    Am I seeing a discrepancy?

  6. [...] others have done that better than me**. So I sign off and wish my reader(s) a very happy and prosperous new [...]

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