Volume XII, No. I

A Belated Happy New Year!

This letter is a bit late because it's taken me a while to decide exactly how to kick things off this year.

On the one hand, given that we're starting the fifth year of the biggest economic and financial crisis of our lifetimes, it would be easy to follow up last year's saga of the European sovereign debt crisis with one of these gems:

• The shocking admission that none of the $1.2 billion in client money stolen by MF Global will ever be found, or
• The Fed's announcement to almost guarantee zero interest rates (thus admitting to practically zero economic growth) until at least 2015

The MF Global debacle (which we may cover in a future letter) is the first time in the history of our financial markets that segregated client money was stolen without restitution made by either the exchanges or the courts.

As for the Fed's declared policy, it is clearly a war against not only savers, but more specifically anyone planning to retire in the near future who might be looking for income – which would include virtually all those planning to retire.

As you can see, the implications of either of these stories (and there are more where those came from) could easily feed the already pessimistic mood that appears to have descended on much of the country.

On the other hand, in the interests of honesty and forthrightness, minimizing the possibly disastrous consequences of these events, or, worse, digging around for sunny, unrealistically optimistic anecdotes just to cheer you up wasn't an option. For sure, we all like good news; I just prefer my good news to be real.

(Indeed, looking back on 2011, I saw that I looked for every possible way to find a silver lining in the financial cloud that burst over us in 2008.)

So in the end, I decided that the best course would be to better equip us to face the future and deal with our world just as it presents itself to us in 2012. And to do that we're going to kick off the New Year with some pretty strong "stuff." This stuff won't make us feel elated, nor will it make us depressed; rather it will give us a clarity of vision that should help us find our way safely through whatever lies in store for us in the coming months and years.

Getting back to that strong "stuff," one thing you should know is it will challenge us. It's not stuff you just take, like medicine or vitamins; it's something you use. We'll have to work with it. As such, it's going to require some effort. But if we make that effort, it should make us all a lot stronger. And stronger will definitely help in 2012.

First, let's kick off with a quick overview of our world today:

• Fact: We're still in the midst of the biggest economic and financial crisis of our lifetimes.
• Fact: There's no clear path out at the moment.
• Fact: Some say things are looking up; some that the world is ending.
• Fact: This is no time to be emotionally swayed either by people telling you everything's fine or by people telling you the end is near. You need to be able to stand up, look around, assess what's going on and think for yourself.

The suggestions that follow will be based on this assessment of where things stand right now.

One more thing before we start: If you followed the three suggestions we made last January:

• Avoid being overly optimistic or pessimistic.
• Expect the unexpected.
• Stay nimble.

...you probably got through the year OK. As a matter of fact, if you did get through 2011 OK, pat yourself on the back. For example, talking about investing, here's what Richard Madigan, chief investment officer for JP Morgan's Global Access Portfolios had to say about 2011:

Of course, if you think 2012 will be easier than 2011, maybe you don't need to read this letter. But if you, like me, think things aren't going to get any easier in 2012, you'll need to stand up, look around, assess what's going on and think for yourself. Or, to look at it another way, cut through all the noise and nonsense that surrounds and inundates us.

So, here's my first suggestion:

Most of us have had the experience of practically drowning in information every day – information that frequently fills our brains and prevents us from really thinking.

The phenomenon of "information overload" is nothing new. Indeed, it seems to get worse every year. So you should probably make the effort to control your attachment – for some of us an addiction – to all those electronic gadgets that have taken over our lives. You'll soon see why it will be critical for us to take back our brains in 2012.

With that in mind, let's get to work. To do that, we'll need two special tools.

• Tool #1: Reason

• Tool #2: Common Sense

Everyone has the ability to reason. The challenge for some of us may be that we don't always make the effort. We read or listen to "information" through our iPhones, iPads, laptops, Youtube, Facebook, even radio and TV. For much of that time, we pretty much passively receive information. But reason requires us to actively use our brains. (My father used to point this out when I was a teenager – and occasionally even after that. His way of saying it was: "Use your head!)

As for common sense, it's true that some of us have a bigger dose of common sense than others. (Again, I can just hear my father – who had a huge dose of this – impatiently declare, when making an important point: "It's just common sense!") Don't worry: whatever dose you have, you've already got some.

The good news is that even a little of each goes a long way.

What Makes 2012 Especially Challenging

Why the emphasis on reason and common sense in 2012? What we need to understand about 2012 is that we've crossed into unknown territory.

If you read our last three letters from 2011 about the European debt crisis, you remember that I proposed a simple, direct explanation of what was really going on:

If you re-read this paragraph you'll see that absolutely no progress has been made on these issues since then, in spite of the European Monetary Union leaders calling for more meetings, resulting in yet more pronouncements, resulting in ever newer schemes to keep the lid on things, resulting in an ever greater flood of reports from the media.

So far, all they've done is kick the can down the road.

And it's not any better here in the U.S.A. Everything the federal government and the Federal Reserve have done so far to deal with our economic and financial crisis also adds up to kicking the can down the road.

But it's what has accompanied all this can-kicking that puts us in unknown territory. We'll let Jim Bianco of Bianco Research explain:

(You can read the whole analysis, charts and all, by clicking here.)

If you've been reading these letters, especially over the last year or so, the concept of government money-printing and its consequences should be familiar to you. The "unknown territory" refers to the global nature of government money-printing. As Mr. Bianco points out, it's unprecedented.

When you're in unknown territory, you have to find some way to make sense of your surroundings. For example, let's say friends of yours recommend you consider a vacation in the Gabonese Republic. Even if you're the adventurous type, you'd probably feel you want to know more than about this country than the fact that it's located in west central Africa, bordering Equatorial Guinea, Cameroon and the Republic of the Congo. Indeed, most of us would need to gain a level of understanding and comfort that would be greater than it might be if your friends suggested a weekend in London, right?

What I'm suggesting here is that government policies of kicking the can down the road combined with central banks engaging in money-printing on an unprecedented global scale is something none of us has ever encountered.

However, there's an even more pressing reason I believe we all need to clearly focus on events as they unfold in 2012. Once you grasp the meaning of the events affecting all of us right now, you'll quickly understand the inevitable fact that these events will radically change our world. If that's not obvious to you now, it will be.

But it's not so much the fact that the world will change that we need to address right now; it's the process – that is, how it will change – that should be our concern in 2012 and for the foreseeable future.

Here are some simple examples of what I mean.

Home values have fallen as much, sometimes more, than home values did during the Great Depression. But back in the 1920s, a far lower percentage of Americans owned homes. More importantly, those who did back then weren't relying on their home equity value to finance their retirement. Few Americans sold their homes and moved to "retirement communities." They lived out their years in the same homes where they raised their families, where they in fact lived for most of their lives.

But today's typical home-owner, if they followed the financial "wisdom" preached to them for decades, believed their homes were their "best investment." They were told that, "real estate always goes up," and so their home equity would grow until it was time to retire. Why bother to build up additional savings and investments when their home equity would be available to them to fund their retirement?

Of course, with home values collapsing, sometimes reducing home equity to zero (or less) for many families, not having additional savings and investments leaves many Americans in a tough situation. We don't really know exactly what this will mean for millions of Americans or how they will react to this new reality – a reality that has just begun to sink in.

What about those thousands of college graduates with five- and even six- figure college debt who either can't get jobs, have been laid off, or are working for wages far below what they counted on when they took on all that debt?

Or how about those millions of private and municipal union employees whose upcoming retirements depend on pension funds which are woefully underfunded, with little hope of being able to meet their obligations?

And we won't even mention what might happen to millions of already-retired Americans currently living on fixed incomes, whose purchasing power already dwindles with inflation every year. What will happen to their lives if, as some suspect, inflation picks up steam in coming years as a result of all that money printing we discussed before?

The personal and social disruption has only just begun. We don't where it will lead.

What We Can Count On – And What We Can't

If what I've said so far makes sense to you, then what we can count on is the simple stark fact that our world will radically change. And if that's so, then it behooves all of us to sharpen our wits and prepare ourselves to confront the ongoing process of transformation – which has already begun – as best we can.

As for what we can't count on, I suggest that would include prudent decisions by either our politicians or our central bankers.

If you're still waiting for either the federal government or the Federal Reserve to "do something" that will get us out of this biggest economic and financial crisis of our lifetimes, I refer you to this past December's letter where I explain in detail why politicians – and this includes central bankers – will not make any of the hard decisions that could make a difference at this time. Those decisions would entail pain – perhaps a lot of pain. And that pain will be felt by the majority of voters.

Using your reason and your common sense, ask yourself this: Is there is any conceivable way politicians will willingly enact policies that will cause such pain if doing so will prevent them from being re-elected?

On the other hand, if your hope lies in the world's central bankers, anyone using reason and common sense, considering the evidence we've just seen, should be able to see that central bankers have decided to engage in historically unprecedented money-printing which, oddly enough, accommodates politicians' desires to avoid pain. (Not only is this not a solution, but those same "easy money" policies, practiced in slightly moderated fashion, led us to the debacle of 2008.)

So what will 2012 (and beyond) bring? I don't know for sure; I wish I did. But I'll venture an educated guess. Here goes.

We're building up to the next crisis, maybe something on the scale of 2008 - or worse. Why do I think this? Because nothing that has brought us here has changed for the better - some of it has even gotten worse.

Whether the next blow-up is like 2008, something worse, or maybe just the next in a series of mini-crises within the overall crisis, at some point one of the following will happen:

• politicians and the Federal Reserve will be forced to make the sort of decisions they need to make to exit this crisis, or
• the next crisis convinces us all to wake up and "throw the bums out," or
• we hit a wall, no one takes any effective action, and everything "comes completely unglued," leading to economic disruption and social unrest on a scale none of us here in the U.S. has ever experienced. (Even if it lasts only for a while, it's clearly the least desirable alternative.)

In any case, I'm convinced that sometime in the next few years (2, 3, 5...?) a day of reckoning will arrive.

There are no easy answers or magic bullets that will make this crisis go away. And there's no sure way to predict exactly how things will play out in the coming months and years. That's why being equipped to understand events as they unfold is so important.

And please don't fall into the trap of thinking that you need a specialized education, years of financial services industry experience, or a PhD in economics. You will find that our basic tools of reason and common sense will allow most of us to grasp most of the important issues.

Meanwhile, I'm going to concentrate my writing on the theme of helping you sharpen your understanding. To get started, I've posted a couple of examples on my blog that specifically use our tools of reason and common sense to understand some important events and issues. You'll find links to them in the "P.S." to today's letter. During the year, I'll post more of these as become necessary or appropriate. You'll find them if you check in to http://rickesposito.blogspot.com/ from time to time.

Best wishes for the New Year,

P.S. – Here are the links to some examples of using reason and common sense to understand important events and issues: How to Know When Something Makes No Sense and Why Medicare Makes No Sense. And if you're up for something more technically meaty, check out this excellent analysis of the misleading unemployment number just posted by the government's Bureau of Labor Statistics. It was posted on the website www.zerohedge.com.

Enjoy!

Richard S. Esposito, ChFC
Lighthouse Wealth Management LLC
405 Lexington Avenue, 26th Floor
New York, NY 10174
Tel: 212-907-6583/Fax: 866-924-1952

Email: resposito@lighthousewm.com