2011 Market Predictions? No; Informed Opinions? Yes!

  • Written by David
  • December 23, 2010 at 3:59 pm
  • 0
  • Ah, the magic of the season. Santa Claus in the shopping malls tending to children’s wish lists, and market pundits lining up to predict the market’s direction for the coming year.

    I find this exercise a waste of time and use several examples to illustrate my point. Every January, Barron’s, the weekly financial newspaper, publishes a four-week series ’roundtable’ discussion with global leaders from the world of finance, economics and asset management to gain insights into the coming year. the quote below says it nicely..

    Barron’s Roundtable when this loquacious and brainy bunch of market savants submitted last Monday to their annual grilling by this magazine’s editors.”

    Let’s go back to 1994. In 1994 the Federal Reserve raised interest rates seven times over a six month period. 1994 was the worst year for bond markets since that data had been recorded. Now, that 1994 Barron’s roundtable discussion; not one of the ‘brainy bunch’ interviewed in 1994 had anything to say about interest rates, let along making the claim that interest rates might rise in 1994.

    Not a believer in the inability to predict?

    Let’s look at the 2008. The Democratic and Republican National conventions were held August 25-28 and September 1-4 2008 respectively. What two words were not mentioned at either convention? Depending upon your point of view, the answer might be ‘tax cuts’ or ‘tax hikes’. No, the two words I’m looking for were ‘sub-prime’.

    Mind you it was over the weekend of Saturday September 13, 2008 (less than two months from the conventions) that Lehman Brother‘s door were closed as it went into bankruptcy liquidation. It was also on that same weekend that other banks and investment firms sought protection from collapse and failure, namely Merrill Lynch throwing itself into the arms of Bank of America to avoid a Lehman style ending. Why where these cataclysmic events of the fall of 2008 not ‘talking points’ of either convention? The inability to predict.

    So there we go, predictions are meaningless, but non-the-less, people continue to offer them. That brings us around to ‘those’ 2011 predictions. Rather than list my predictions, I have listed topics which I believe should be in the minds of any investor over the foreseeable future as one constructs and/or re-balances his/her asset allocations.

    10 Good Reasons To Be Worried About The Stock Market In 2011

    (Click above title to access report at BusinessInsider.com)

    This work is from David Rosenberg of Gluskin-Sheff. (Rosenberg was Merrill Lynch’s Chief Economist for North America before departing for Gluskin-Sheff) In his latest daily note, the Gluskin-Sheff economist presents 10 reasons bulls should be worried about the stock market in 2011.

    1. In Barron’s look-ahead piece, not one strategist sees the prospect for a market decline. This is called group-think.  Moreover, the percentage of brokerage house analysts and economists to raise their 2011 GDP forecasts has risen substantially.  Out of 49 economists surveyed, 35 say the U.S. economy will outperform the already upwardly revised GDP forecasts, only 14 say we will underperform.  This is capitulation of historical proportions. The last time S&P yields were around this level was in the summer of 2000, and we know what happened shortly after that.

    2. The weekly fund flow data from the ICI showed not only massive outflows, but in aggregate, retail investors withdrew a RECORD net $8.6 billion from bond funds during the week ended December 15 (on top of the $1.7 billion of outflows in the prior week).  Maybe now all the bond bears will shut their traps over this “bond-bubble” nonsense.

    3. Investors Intelligence now shows the bull share heading up to 58.8% from 55.8% a week ago, and the bear share is up to 20.6% from 20.5%.  So bullish sentiment has now reached a new high for the year and is now the highest since 2007 ― just ahead of the market slide.

    4. It may pay to have a look at Dow 1929-1949 analog lined up with January 2000. We are getting very close to the May 1940 sell-off when Germany invaded France.  As a loyal reader and trusted friend notified us yesterday, “fighting” war may be similar to the sovereign debt war raging in Europe today. (Have a look at the jarring article on page 20 of today’s FT — Germany is not immune to the contagion gripping Europe.)

    5. What about the S&P 500 dividend yield, and this comes courtesy of an old pal from Merrill Lynch who is currently an investment advisor.  Over the course of 2010, numerous analysts were saying that people must own stocks because the dividend yields will be more than that of the 10-year Treasury.  But alas, here we are today with the S&P 500 dividend yield at 2% and the 10-year T-note yield at 3.3%.

    From a historical standpoint, the yield on the S&P 500 is very low ― too low, in fact. This smacks of a market top and underscores the point that the market is too optimistic in the sense that investors are willing to forgo yield because they assume that they will get the return via the capital gain.  In essence, dividend yields are supposed to be higher than the risk free yield in a fairly valued market because the higher yield is “supposed to” compensate the investor for taking on extra risk.  The last time S&P yields were around this level was in the summer of 2000, and we know what happened shortly after that. When the S&P yield gets to its long-term average of 4.35%, maybe even a little higher, then stocks will likely be a long-term buy.

    6. The equity market in gold terms has been plummeting for about a decade and will continue to do so.  When measured in Federal Reserve Notes, the Dow has done great.  But there has been no market recovery when benchmarked against the most reliable currency in the world.  Back in 2000, it took over 40oz of gold to buy the Dow; now it takes a little more than 8oz. This is typical of secular bear markets and this ends when the Dow can be bought with less than 2oz of gold.  Even then, an undershoot could very well take the ratio to 1:1.

    7. As Bob Farrell is clearly indicating in his work, momentum and market breadth have been lacking. The number of stocks in the S&P 500 that are making  52-week highs is declining even though the index continues to make new 52-week highs.

    8. Stocks are overvalued at the present levels. For December, the Shiller P/E ratio says stocks are now trading at a whopping 22.7 times earnings! In normal economic periods, the Shiller P/E is between 14 and 16 times earnings.  Coming out of the bursting of a credit bubble, the P/E ratio historically is 12.  Coming out of a credit bubble of the magnitude we just had, the P/E should be at single digits.

    9. The potential for a significant down-leg in home prices is being underestimated.  The unsold existing inventory is still 80% above the historical norm, at 3.7 million.  And that does not include the ‘shadow’ foreclosed inventory.  According to some superb research conducted by the Dallas Fed, completing the mean-reversion process would entail a further 23% decline in real home prices from here. In a near zero percent inflation environment, that is one massive decline in nominal terms.  Prices may not hit their ultimate bottom until some point in 2015.

    10. Arguably the most understated, yet significant, issue facing both U.S. economy and U.S. markets is the escalating fiscal strains at the state and local government levels, particularly those jurisdictions with uncomfortably high pension liabilities.  Have a look at Alabama town shows the cost of neglecting a pension fund on the front page of the NYT as well as Chapter 9 weighed in pension woes on page C1 on WSJ. Consumer spending was taken down 0.4 of a percentage point to 2.4%, which of course you never would have guessed from those “ripping” retail sales numbers In the absence of Chapter 9 declarations or dramatic federal aid, fixing the fiscal problems at lower levels of government is very likely going to require some radical restraint, perhaps even breaking up existing contracts for current retirees and tapping tax payers for additional revenues. The story has some how become lost in all the excitement over the New Tax Deal cobbled together between the White House and the lame duck Congress just a few weeks ago.


    Real GDP was revised up a tenth of a point to 2.6% at an annual rate for Q3 but it really felt more like a downgrade than an upgrade when you sift through the details.  Consumer spending was taken down 0.4 of a percentage point to 2.4%, which of course you never would have guessed from those “ripping” retail sales
    numbers.  The problem with those monthly reports is that they only represent a fraction of total personal expenditures ― what led the downward revision were services.

    There were no other major changes except to inventories, which are now reported to be $121.4 billion at an annual rate from $111.5 billion initially.  Real final sales were taken down to a mere pittance of a +0.9% annual rate from +1.2% in the last Q3 GDP revision go-around.  This mix of higher than expected inventories and lower than expected real final sales is a cloud over current quarter GDP ― just after all the latest round of upward growth revisions by the consensus economics community

    Bespoke Investment Group: 71% Bullish on 2011

    “Up until recently, the contrarian call on equities was that they were headed higher. Based on all of the sentiment polls we’ve seen recently, however, the contrarian call has shifted to the bearish camp. The majority now appear to be bullish.”

    Three Reasons to be Prudent:

    1.) Fundamental-Very High P/E Ratios

    “As a result of the recent spike in corporate earnings, however, the PE ratio currently resides at a level not often seen over the past two decades.”

    2.) Technical-Complacency abounds

    “The VIX is fast approaching levels that are consistent with very high complacency. I know – most investors currently believe that, stocks can’t go down, the economic recovery is here, and that it’s a “win, win” market, etc. I disagree and this “technical” indicator is a solid reason why. The VIX sinking below 15 – 16 is a sign that investors are increasingly confident, removing hedges and leaving their portfolios exposed to greater risk. Think about that!

    Many of the most brutal sell-offs in recent years were accompanied by the exact same environments – government had intervened to save the economy. All is going to be well in the world, and on and on. The market has a way of fooling the majority of investors the majority of the time. It is looking like a very good time to be hedged – or in cash, not necessarily because you’re bearish, but because it’s the currently the wisest/prudent investment strategy to maintain.”

    2.) Consensus=Everyone’s ‘in the pool’!

    “For most Investors, the single most important piece of information and data are earnings. This is ok, but using a Pavlovian response to published data is often taken as “fact” – frequently leading to poor investment decisions. Don’t just follow; get a perspective of who is thinking – bull or bear. It is clearly wise to “go with the flow” rather than buck the consensus trend. That’s called consensus analysis.”

    Source: Seeking Alpha

    By no means is this an exhaustive list of problematic areas around the globe that could handily upset the ‘repricing of risk’ going forward. Polite way of saying, if the markets should plummet because investors underestimated risk .

    Margin Debt Soars to Highest Levels Since September 2008

    (Click above title to access report)

    “Margin debt is one measure of the amount of optimism or pessimism in the stock market. Rising margin debt generally correlates to a rising stock market. Margin use has soared to the highest level since September 2008.”

    Source: Mike “Mish” Shedlock http://globaleconomicanalysis.blogspot.com

    Don’t believe the rosy forecasts

    (Click above title to access report)

    “According to Roberts, Friedman delivered a brief, cutting critique––”Why would this extremely complex model, based on factors that are themselves hard to forecast and could easily be wrong, produce a better number than taking the growth rates for the past five years, and dividing by five?”

    Friedman’s lesson isn’t that forecasting is impossible, but that the best prediction is usually the basic assumption that prices and growth rates will go back to their historic averages, or in economic parlance, “revert to the mean.” What’s difficult is guessing when that will happen. Indeed, the timing is truly unpredictable. But it invariably does happen.”

    Source: Fortune Magazine


    Ok, here’s what we have right now

    • High Stock Market Valuations-PE Ratios
    • High Investor Complacency-VIX Index
    • High Investor Sentiment-Contrarian Indicator
    • Debt Problems: Europe, USA State and Local Governments
    • Global conflicts around the world, North Korea, Iran Pakistan
    • Excessive Margin Balances
    • Above the ‘mean’ trendlines in many areas of the economy

    So, let’s just say you sold your business at year-end 2010; are you going to invest those hard earned lifetime proceeds in the market today? If so, how would you construct your asset allocation given the knowledge above? I’m just asking.

    I continue to exercise prudence and care in client asset allocations using wealth preservation and inverse asset strategies to protect from potential large market losses.


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