Outlook 2011: Climbing the Wall of Worry?

Let
me first wish all my readers a Happy New Year full of health &
happiness. It's that time of year where I reflect on what lies ahead.
Last year I wrote about Black Sloths and commented:

...the
global pension crisis will not disappear overnight. It is a long-term
structural issue that will plague governments for years. In fact, part
of me thinks that the Fed and other central bankers will try to
engineer inflation to partly offset future pension liabilities.

My
worst fear is that they will fail miserably, creating another
generation of paupers. I hope I am wrong, but this remains my worst fear
for the next few years. I do hope monetary authorities and governments
take the pension crisis more seriously.

Governments around the world are taking a closer look at pensions,
especially public pensions, but I'm not convinced they're moving in the
right direction. I worry that instead of bolstering retirement systems
around the world, we are weakening them, leaving far too many people
exposed to the vagaries of "sophisticated" wolf markets. This virtually guarantees more pension poverty down the road.

As
for monetary policy, the Fed continued engaging in quantitative easing
(QE) in order to reflate risk assets and is engineering inflation,
including inflation in emerging markets.

I
still maintain that the financial oligarchs and power elite have vested
interests to keep the current financial system alive for as long as
possible. Their worst fear is to be trapped in a prolonged period of
debt deflation. That's why I still think the dips will be bought and that
liquidity flows will continue driving risk assets higher in 2011.

But every year is different. The easy money was made in 2009 following post-deleveraging blues.
Going forward, it will be much harder to make money off broad market
moves, and deleveraging hasn't gone away, but I also think the world
isn't half as bad as many bears scare us into believing.

Before
you sell all your stocks or do anything extreme, take a step back and
read some predictions for 2011. Let's begin with Larry MacDonald who
reports in CTV, Reasons to be both bullish and bearish in 2011:

In
1931, The New York Times celebrated its 80th anniversary by asking
Henry Ford and other luminaries to forecast what the world would be
like in 2011, another 80 years ahead. As the archives on the newspaper’s
website reveal, Mr. Ford envisioned more success “in passing around
the real profit of life.”

He may prove to be right. Investment
strategists, most economists and investor sentiment surveys see higher
stock markets and economic growth in 2011. But there are voices of
dissent, or at least caution. Here are three reasons to be bullish for
2011 – and three reasons to be cautious.

Bullish: improving economic signals

Recent
U.S. economic indicators hint that the self-sustaining phase of the
business cycle may be close at hand. Retail sales have trended up since
July to a three-year high, while jobless claims have declined, leaving
the four-week average at its lowest point in nearly two and a half
years.

The widely watched Weekly
Leading Index published by the Economic Cycle Research Institute (ECRI)
has risen to its best readings since May 28. Money supply and credit
aggregates are turning up as well, observes institutional advisory BCA
Research, suggesting banks are beginning to lend and firms to borrow.

Bearish: housing sector missing in action

Historically,
the housing market leads U.S. economic recoveries. But stimulus so far
has been “inadequate to lift home construction and sales,” reports
Asha Bangalore, senior economist at the Northern Trust Company in
Chicago.

Adding to concerns, the S&P/Case-Shiller Home Price Index has started to go down in recent months and could fall further.
“There is still roughly two years of unsold inventory overhanging the
market once the ‘shadow’ foreclosure backlog is included,” Gluskin
Sheff chief economist David Rosenberg declares.

Bullish: supportive policy

Sparked
by earlier fears of a double-dip recession, U.S. policy makers
recently announced new measures to boost the economy. Bush-era tax cuts
were maintained, the payroll tax temporarily cut by 2 per cent, and
unemployment benefits extended.

The Federal Reserve announced a
second round of quantitative easing, committing to the purchase of
$600-billion (U.S.) in U.S. government bonds by June. The Fed wants to
keep five- and 10-year Treasury yields down and encourage U.S. banks to
lend rather than park funds in Treasuries, economists say.

Bearish: bond risk

If
stimulus leads to growth quickening too much, the bond market could
sell off, causing yields to shoot up and undermine the economy. The
flash point is currently 3.8 per cent for 10-year U.S. Treasury
yields, according to models developed by Peter Gibson, the CIBC World
Markets chief portfolio strategist who has earned top rankings in the
Brendan Wood International survey of analysts since 1994.

If yields breach this ceiling, the Fed will try to hammer them down with quantitative easing. If
that doesn’t work, the Fed could raise short-term rates to appease the
bond market with the prospect of economic slowdown, Mr. Gibson says.

Bullish: healthy corporations

U.S.
corporations are “in phenomenal shape” writes Tony Boeckh in the Dec.
17 issue of the Boeckh Investment Letter. Profit margins, at 8.7 per
cent, are way above the long-term average. And cash balances are huge,
led by the technology sector with a cash-to-equity ratio that exceeds
25 per cent.

If the recovery picked up, “those cash holdings
could be used for M&A activity, capital investment, share buybacks
and, of course, higher dividend payouts,” Mr. Gibson writes. Exceptions
may be exporters who keep cash balances offshore.

Bearish: state and local cutbacks

“One
shock is the sharp pending drag from widespread and accelerating
spending cutbacks and tax hikes at the fiscally strapped state and local
government level [in the U.S],” Mr. Rosenberg points out. “This
promises to be a major macro theme for 2011.”

Funding pressures
are going to be more intense when the “Build America Bond” program winds
up. “The sector has laid off 250,000 people in the past year and more
is to come as this crucial 13-per-cent chunk of the economy moves
further into downside mode,” he adds.

We continue on a bullish note which seems to be the consensus. Bob Doll, Chief Equity Strategist of BlackRock makes his 10 predictions for 2011:

1. US growth accelerates as US real GDP reaches a new all-time high.

2. The US economy creates two to three million jobs in 2011 as the unemployment rate falls to 9%.

3.
US stocks experience a third year of double-digit percentage returns
for the first time in more than a decade as earnings reach a new
all-time high.

4. Stocks outperform bonds and cash.

5. The US stock market outperforms the MSCI World Index.

6. The United States, Germany and Brazil outperform Japan, Spain and China.

7. Commodities and emerging market currencies outperform the US dollar, the euro and the Japanese yen.

8.
Strong balance sheets and free cash flow lead to significant increases
in dividends, share buybacks, mergers and acquisitions and business
reinvestment.

9. Investor capital flows move from bond funds to equity funds.

10.
The 2012 Presidential campaign sees a plethora of Republican
candidates while President Obama continues to move to the political
center.

I tend to agree with most of these
predictions, especially the ones I put in bold. One of the key things to
watch for is how capital flows out of bond funds into equity funds.
While stocks are likely to outperform bonds, I'm not bearish on bonds. I
don't see inflation in the US and backups in long bond yields present
opportunities for investors to pounce.

Importantly, the Fed will
do whatever it takes to make sure bond yields do not wreak havoc on the
financial system. The problem is that some feel we didn't need QE2 and
there is way too much stimulus in the pipeline. Maybe the bond market is
worried that another round of QE will propel yields higher. One
portfolio manager told me: "we don't need more QE; it's going to
backfire big time!". The same portfolio manager sees the curve
flattening in 2011 as short rates rise in anticipation of Fed rate hikes
in 2012.

And what about Doll's prediction that the US market
will outperform all other markets? It might very well be the case, but
Bernard Lapointe wrote an interesting comment in the Sceptical Market
Observer claiming that 2011 may be the year for Japanese stocks. Who knows? I see liquidity flows continuing to drive US stocks higher.

As
far as commodities, the biggest risk I see going forward is the price
of oil overshooting $100/barrel. Forget the "imminent collapse of the euro
zone" (won't happen) and pay attention to oil because the biggest risk
to the recovery is the price of energy.
I remain bullish on energy and alternative energy where I see a
long-term secular bull market developing (and potential bubble). Higher
energy prices will be positive for the Canadian stock market.

Finally,
listen to Barton Biggs, Traxis Partners and Jeffrey Gerson, Gerson
Guarino & Meisel Group founding partner provide their predictions
and outlook for 2011. Gerson says the housing double dip is likely to
worsen in 2011 and will pressure the economy. Gerson is approaching
the markets in a cautious and tactical manner because he believes the
market is unlikely to regain the highs as soon as many might think.

Barton
Biggs, however, is extremely bullish. Although he believes the market
is overbought he says the market can continue to rally higher in the
early portion of 2011. I agree with Biggs, especially on emerging
markets, which is why I believe markets will climb the wall of worry.

Comments

[topcallingtroll]

In terms of pensions when you have both democrats and republicans in revulsion at the fat pensions of unionized bureaucrats then change is inevitable.  Pensions can no longer be funded as ponzis since the population is not growing fast enough.  I am hopeful that this will lead to a revulsion in general against government action and our society will become more libertarian.  Who would have thought that George Bush Jr. was the democrats best asset?  Who would have thought that public sector unions would bring about the downfall of activist, expansive government?  Strange world isn't it.

[docsdoc]

And Citigroup will be a top performer in 2011...

[markmotive]

I know there's a lot of bad news out there - finding negative news is easy. The real challenge is to find pieces of good news.

Maybe financials are still underwater and home prices keep declining...but it seems like the employment situation is beginning to improve:

http://www.planbeconomics.com/2011/01/01/6-charts-that-show-labor-market-is-improving/

Now here's a strange thing to say...I second-guessed posting this here because I know that anyone saying anything remotely positive on the economy is summarily dismissed. But in an effort to maintain open discussion I posted this anyway.

You may proceed to lecture me now...

[UninterestedObserver]

Like posting a bunch of BLS charts somehow proves your point? Fucking moronic.

[markmotive]

I'm just trying to stir up a little debate...

I find it a good analytical exercise to try to argue the underrepresented side of a viewpoint. It keeps me honest.

[snowball777]

You may proceed to lecture me now...

Da-duh-duh da da....you're lovin' it!

Kudos for whatever bravery drove you out onto this limb, but there's a huge difference between temp gigs at a loading dock and solid construction work. If you look at the aggregate income those job gains are meaningless (at least to recovery...though they will provide fodder for the propagandists).

[Snidley Whipsnae]

I have one question; Where is the driver for jobs going forward?

Anyone that buys into the BLS stats with their 'black box' birth/death model is delusional. The BLS even admits on their website that during times of rapid job increases or decreases that their predictive model can be very far from what is happening in the real world job markets.

Last; What is the point of 'looking for good information'? Why not instead look for the truth? If you look for good information you will find it in stats generated by a failing government and a failing financial system. What good will that do the citizens that will have to face the truth eventually? I say let them face the truth now and let the insolvent, over indebeted system collapse so that we can begin on the road to a sound economy.

Enough happy talk already!

Happy New Year Leo and all!

[akak]

Last; What is the point of 'looking for good information'? Why not instead look for the truth? If you look for good information you will find it in stats generated by a failing government and a failing financial system. What good will that do the citizens that will have to face the truth eventually? I say let them face the truth now and let the insolvent, over indebeted system collapse so that we can begin on the road to a sound economy.

Excellently said Snidely!

But I suspect that Leo would take issue with such blunt honesty --- don't you know it's REALLY all just about short-term profits, truth and morality be damned?

[Eally Ucked]

BLS stats will improve more, this year we will have somewhere around 3.5 mln boomers eligible for retirement.  

[Ned Zeppelin]

"Where is the driver for jobs going forward?"

Been my point for months.  There is none.  Nor is there a driver for housing to recover. I think these predictions of high GDP growth do not account for some big fundamentals.  Once unemployment insurance starts to drop off, as being unaffordable, that stimulus will fade, and there is no "next big thing" in the wings because of our collective failure to have as one of our policies the promotion of US manufacturing. We used to build stuff, then we built houses, now we build very little.  And the huge income and wealth gap only gets worse - by design of course. 

Time to tax the rich big time. 

[Kayman]

Job growth

1. Unpacking boxes at Walmart stamped with Made in China.

2. Private Security to protect the ill-gotten gains by the criminal bankers.

3. Government check receivers.

[UninterestedObserver]

That's fine but then you need to provide factual data to discuss - no point debating the govt lies..

[JW n FL]

No... AIG will double up for top spot, again!