to HomeLOOKING AHEAD TO 2011
A Special Report by Chris Temple -- Editor
January 1, 2011
Exactly a year ago, my method of handicapping what I saw ahead for us in the year just concluding was to take the then-most popular predictions by the consensus and disagree with each. Called my "ANTI-Predictions for 2010" -- which you can still read on the front page at www.nationalinvestor.com, together with my mid-year follow-up and "scorecard" -- I explained why the calls for higher interest rates, a plunging dollar and more were all wet.
This time around, there are likewise some consensus predictions that appear oh so vulnerable! At the top of the list is the near-unanimity among market watchers that 2011 will be yet another strong year for U.S. stocks. That is certainly possible, especially given the fact that Federal Reserve Chairman Ben Bernanke is hell-bent on keeping stocks levitated and moving higher. Some are predicting another year of double-digit gains for equities for little reason other than the fact that this is President Obama's third year in office; and we all know that stocks always go up in the third year of a president's term, don't we?
A couple of major monkey wrenches could be thrown into this picture, however. You will read of a few of those below.
This year--rather than come out with a few high profile "anti-predictions" or many predictions of my own--I am choosing instead to have just a simple discussion. Imagine you and I sitting and visiting over a cup of coffee or a cocktail. We will simply have a sober, wide-ranging discussion about all the possible things (or a good number of them, anyhow) that could happen in 2011. Some might coalesce to indeed give U.S. financial assets in particular a good year. Enough bad news, however--or, more to the point, bad events elsewhere--could just as easily throw us right back into the late 2008-early 2009 deflationary mess and financial troubles.
So without further ado, let's at least start close to home and talk about...
THE U.S. ECONOMY
Much has been written about the growing gap in America between rich and poor. Between Wall Street and Main Street. I daresay the majority of the people in this country are having a difficult time understanding how and why the stock market can reach its highest level in a bit over two years. They certainly don't see any recovery.
This disconnect was, to me, starkly illustrated by the headline I saw a few days ago on CNNMoney.com. It read, "Economist survey: Growth improving but not jobs, housing." Let that headline sink in for a minute. Correct me if I am wrong; but isn't pretty much the entire consumer-driven economy dependent on jobs and housing?
Just as I am releasing this report, the government told us (on Thursday morning, December 30) that weekly jobless claims fell below 400,000 for the first time in over two years. Not everyone did handsprings; it was widely acknowledged that the Christmas holiday season regularly "messes" with statistics and that we will need to see a couple or three weeks' worth of numbers in the New Year ratify this trend. Hopefully--if you are bullish--that will be punctuated by an improvement in the unemployment rate itself, together with a meaningful increase in new job creation.
I for one am not holding my breath waiting for a significant decline in unemployment. Corporate America has already rebuilt inventories somewhat; now, it wishes to see the bump higher in retail sales of late continue into 2011. Only then might corporate chieftains think about hiring more workers, etc. Otherwise, we will see more in 2011 of what we did in 2010: corporations sitting on record amounts of cash (nearly $2 trillion recently, with cash comprising the greatest share of corporate assets since 1959) and doing little else with all the dough than occasionally buying a smaller competitor.
Unlike in the early part of the decade just concluded, Americans no longer have their home to use as an ATM machine when their wages stagnate or disappear. As I will be writing in more detail in the near future, the real estate market generally remains in a deleveraging/unwinding posture that will last at least another couple of years. Indeed, many others are now embracing what I have been insisting on for over year: the realization that there truly is presently no end in sight for those looking for a final "bottom" in housing prices. About the only thing that will keep real estate from a double-digit loss in market value in 2011 will be if one of the dire scenarios covered further in materializes: basically, a bursting of the Chinese bubble or the disintegration of the euro. Either one or both of those would cause a mad rush into both dollars and U.S. Treasury securities, and cause recently-rising mortgage rates to plunge anew.
Basically, I don't believe it will be long before the pundits once more figure out that the economy is not as healthy as they have been led to believe by Wall Street. Once this sinks in, it will be a depressant for both stocks and commodities.
WHAT WILL HAPPEN IN CHINA?
I've spent a considerable amount of time speaking on China in recent months. The manner in which this once-great empire seeks to become one again is fascinating to watch; indeed, I wish policymakers in this country would take a lesson or two in the kind of patient, long-range planning as is evidenced over there.
Having said that, it has become ever more apparent in the last few months that despite their many advantages over the "American" system of finance, China has nonetheless allowed too much credit creation and too much speculation. As I wrote recently for subscribers, I think the odds of an actual "bust" occurring as China attempts to tap on the brakes have grown considerably. As we head into 2011, the question in my mind is not whether China will be able to slow inflation and further rein in reckless credit expansion, hoarding and all the rest. The question is whether it will
overdo things and--aggravated by that and/or other outside factors--endure its latest bust.
The country's leaders have recently reassured the world that they know what they are doing... that they really can bring about stable growth while "managing" inflation and all that. It was amusing to hear more than one economist lately who is skeptical of such a Pollyanna attitude comparing China's assurances to those of Ben Bernanke; he famous for telling us that there was no real estate bubble and--after being proven wrong on that--that the wreckage would be confined to those with subprime mortgages.
But who knows? Maybe China can pull it off. As I have said before, one major advantage they have is that their banking and financial system is a tool of the state; unlike here and in most other "Western" nations where finance owns the state and the people. But even this may not make China completely immune to the simple laws of mathematics that are implicated when uncontrolled and reckless credit issuance--no matter where it comes from--simply runs too far ahead of a sound economy.
Recent reports on real estate prices in China's major cities bring back memories of Japan at the peak of its crazy bubbles of about 20 years
ago. In one recent story published in the Financial Times it was described how a suddenly new past- time for Chinese people on the Internet was to sarcastically estimate how long it would take some citizens to work to be able to afford a small apartment in downtown Beijing. According to the story, a tiny 100 square meter apartment in the city currently sells for the equivalent of $450,000. Most of China's citizens would not be able to afford it in their lifetimes.
The stakes for China are extremely high. As those of you who follow this country and its dynamics realize, China is trying to manage a very delicate balancing act. It must keep the economy growing fast enough to keep enough of the masses in line and content. Recently--as things have grown too fast, and as speculation everywhere has become more prevalent thanks to the Fed and other central banks frantically shoveling money into the system to keep deflation at bay--things have been going a little too well. This has resulted in soaring prices for the necessities of life. That has caused China once again to raise official interest rates and--just a couple days ago--to also boost minimum wage levels for some workers by 21%. Clearly, the country has been sucked into the same kind of wage-price spiral higher that America went through in the late 1970s.
The stakes for the world's investors in China succeeding in bringing about a soft landing are also high. Most obviously, too much tightening of policy and an eventual bust would cause most commodity prices to crash. As I've written more than once, that won't upset China too much in the grand scheme of things; after all, they will later be able to take their massive foreign exchange reserves and tie up that much more of the world's resources at bargain prices. Between here and there, however, a lot of naïve investors who think commodities can only go one direction will get their heads handed to them again.
Domestic investors in Chinese stocks are voting with their feet. While U.S. markets (and a good many others) are ending 2010 on a high note, owners of Chinese domestic "A" shares are getting while the getting is good. Some market watchers are understandably nervous over this, as am I.
A BROADER EMERGING MARKETS BUBBLE?
You know the old saying that those who refuse to learn from history are doomed to repeat it. In the investment world, one of the things people especially seem to forget quickly is that what we call emerging markets today have chronically been bedeviled by a series of boom and bust cycles over the years. Yes, I know and understand that--for a great many reasons, most of which bring me no joy as an American--countries like China, India and Brazil will be powerhouses in the future. But I still suggest it is too early in the march of time to expect these countries and their markets to be completely impervious either to large financial dislocations or the continued weakening of the Western world and its economies.
Once again, we see most of these emerging market nations at risk not from their own organic growth, rising living standards, resource development and the rest. Instead, they are at risk once more from capital. Time and again, as I have often described it, these nations resemble a kiddie- size wading pool into which a 300 pound man jumps. Such is the effect when massive amounts of speculative capital--more so today, thanks to Bernanke's QE-II and similar efforts by the European Central Bank--are looking for any kind of attractive new home. The problem invariably is that something happens to cause these capital flows into emerging market debt, equities and currencies to suddenly reverse, wreaking havoc on nations which overnight become pariahs to investors rather than their new darlings.
Everyone in policy circles at least knows that this is a clear and present danger again, even if giddy investors haven't figured it out. That is why most emerging nations themselves are taking steps (though, I fear, belatedly) to try and insulate themselves from this new currency war that the Federal Reserve has started. It is not in their interests to have strong currencies. It is not in their interest to have unfettered movement of "hot money" in and out of their countries; some still do remember how the entire world nearly imploded as a result of the Asian crisis in the late 1990s.
2011: DECISION TIME
FOR THE EURO
To me, the economic/political story of the year stands a better chance of involving Europe than China. Simply put, I believe that 2011 will be "do or die" for the grand experiment of forcing a common currency onto widely disparate individual and sovereign (for the moment, anyhow) nations.
Since I am writing in some detail on this in the regular month-end issue of The National Investor (the December one, which subscribers will read in the first few days of January) I'm not going to take a lot of time here. For the rest of you, though, I want to make a couple points.
Don't forget that the euro was the price Germany was asked to pay for reunification. The theory is that the peace would be kept on the continent if everybody had a stake in the same economic and currency "pie." That never really did sell with the masses of Germans however; and does even less so now, as the country is asked time and again to cover others' losses and foibles.
The new year may actually see warfare increase as a result of some folks' backlash against the euro. Ireland is especially a tinderbox. It was only a few years ago that the Emerald Isle was thought to be the economic and financial wizard of the euro zone. Now--with its banking system beyond even insolvency--Ireland may well be the poster child in the New Year as the euro's custodian seek to, basically, take over the country.
Making the dictates of the country's "absentee landlords" even more distasteful to many Irish is the fact that they will be abetted by a non-member (for now) of the euro experiment: Great Britain. English banks, after all, are on the hook for Ireland's financial mess as much as anybody. Some opponents of the euro in England are worrying aloud now that--to "save their interests"--England itself may have little choice but to finally join the euro. That may well bring us a political crisis in England to go with a new civil war in Ireland.
Sheesh-- I haven't even mentioned Spain, Portugal, Italy, Greece (and now, of all things, Belgium and even France!) What a mess.
The creators and custodians of the euro and of the European Commission are on the ropes. Their whole scheme never has been popular with the masses of people; and it is less so now. Whatever we may think of the wisdom (or lack thereof) of how they manage their finances, we cannot expect citizens of so many nations to long put up with the "austerity" being foisted on them. As you long-time readers already know, all of the world's debt woes are a result of fractional reserve banking first-- and stupidity on the part of public officials second.
The E.C. has its work cut out for it this year: either bring about a fiscal union to go with the monetary one-- a true "United States of Europe" -- or see the euro crash and burn.
If China does not "accomplish" this first, it could well be renewed fraying for the euro zone (if not its implosion) that undoes all of Ben Bernanke's deflation-fighting efforts and causes an unwinding that will make late 2008 look like child's play.
INSOLVENT STATE AND LOCAL GOVERNMENTS
There's one key thing I want to stress here; both in regard to Europe's woes just mentioned and those here in America. It is a theme I will hit again and again in the coming months; indeed, a dynamic that will increasingly overwhelm governments and markets.
And that is, folks, that much of the world has gone from an environment where debts are unpayable, to one where they are not even serviceable.
The debt load in America, as measured against the nation's output, is now higher than it was at the onset of the Great Depression. This essentially guarantees what we saw back then (if we're lucky): a generation-long process of deleveraging, default and frugality. It will matter little what policymakers do to try to goose the economy back to some kind of "growth." It will be a moral victory in the end if Bernanke (and, later, his successors) can merely negate some of the deflationary effects of all this.
We've seen over the last few years the effects of this on real estate. Here in America we will also soon see this more acutely where it comes to state and local governments. Well-known financial analyst Meredith Whitney has just warned that as many as 100 cities in the U.S. currently face default on their municipal debt. Local governments simply do not collect enough tax revenue these days in a chronically weak economy to maintain past levels of services, employment--and increasingly pensions. Reports are bound to increase of even more troubles. Indeed, one of the reasons why I am skeptical about the whole employment picture going into 2011 is because it appears likely that any jobs "created" by the private sector will be eliminated by the public sector.
Washington does not quite have the handicap institutionally as it is inevitably called on to deal with this as does the European Commission. Wisconsin, Illinois, California and the rest are not sovereign nations. The Civil War (or for those unreconstructed of you out there, "The War of Northern Aggression") settled that. About the only thing to stop Washington as it has to increasingly paper over local government woes will be the new G.O.P. leadership of the House of Representatives.
Which means that there will be no end to bailouts from Washington until the currency--and the Empire--collapses.
Fortunately for investors in American financial assets, we are more likely to see a repeat of what we did for a while in 2010: an environment where despite this, we are viewed as "less bad" for now than Europe (and, perhaps, China and other emerging markets.) So--relative to other major exchanges--America's financial assets may well outperform for much of the coming year.
ASSORTED OTHER INVESTMENT CONSIDERATIONS
2011 will, of course, see the continuation of valiant (if ultimately doomed) efforts on the part of central bankers and policymakers to throw enough new "money" (actually, new debt) at all of the problems caused by too much old debt. In 2010, the result was meaningful growth in some emerging-market nations, anemic growth in the developed world and melt-ups in the prices of most risk assets.
Unlike the year just concluding, however, 2011 is unlikely to witness the same kind of relatively benign and happy environment (if we carve out the month of May, 2010 that is!) As detailed and explained above, I feel quite strongly that many of the problems that were postponed this last year by all the money printing, QE-II, P.O.M.O. and all the rest won't be so easily put off in this next year.
If we are all lucky, we will lurch from one nasty headline (China, Europe, Iran, etc.) to the next without major damage being done to our portfolios. We will go through a fairly choppy year punctuated by two or three nasty selloffs, the first of which should occur shortly after the beginning of the year if for none other than technical reasons. In the end, we might end 2011 with modestly higher stock and bond prices; but we will have paid a dearer price in the terms of lost sleep on the way there than we did even in this last year.
I continue to see things differently than the consensus; and for a variety of reasons I will continue to explain to subscribers view commodities generally as vulnerable. As I have said, they are not merely some magical new asset class that has to go up because central bankers are debauching their currencies (especially the dollar.) They are also a cost of goods sold for businesses. They are rising costs of living for consumers. And with much of the world increasingly dealing with now unserviceable debts, I feel even more that 2011 will prove my contention that a good part of the world can service its debts OR pay ever higher prices for food and fuel--but it can't do both!
In closing, allow me to offer a few more specific "takes" on a certain few assets/markets:
--- My "no-brainer" call for early 2011: Go long U.S. Treasuries.
I was basically correct in the same call in January, 2010. It was only in the last several weeks of the year that Treasuries surrendered all of their 2010 gains, however, as yields on long-term paper spiked. But following the recent beating they have endured, I believe that Treasuries will rally in the near-term for a host of reasons:
1. The economy cannot grow sustainably on its own and--led by renewed declines for housing--is likely to weaken anew.
2. A correction for stocks and commodities early in the new year will also feed a rally in government debt generally, and U.S. debt particularly.
3. A Chinese slowdown--or worse.
4. New turmoil for the euro--or worse.
--- A HUGE move possible for the U.S. dollar. We are most likely to have a sort of "rolling devaluation" among pretty much all major currencies this year. Thus--while I am optimistic about the near-term prospects for Treasuries--I am not as convinced as I was at the beginning of this past year that the dollar would have enough of a sustained rally for us to trade into.
Having said that, though, if either China or Europe get sicker than most people currently expect, the dollar could have an explosive move upward as deflation and risk aversion overwhelm the regimen of recent months--perhaps overnight.
--- TWO (or even THREE?) HUGE moves possible for gold. In this last year, gold enjoyed a status it has not held in a generation: that of a reserve asset--money--in its own right. We have not seen the last of that, despite the predictions of some that gold has entered "bubble" territory.
The yellow metal--and proxies such as silver--will continue to benefit over time from the inexorable erosion of fiat currencies; especially the U.S. dollar they are most commonly priced in. Many gold bugs are predicting continued, fairly steady gains for their favorite asset in 2011.
At the same time, there are those who insist that everything is overstretched; and that--especially if the troubles in China and/or Europe cause new waves of deleveraging and deflation, even gold will get whacked.
I agree with part of that.
The question in my mind will be the timing of these events. Further, we must distinguish between what a disintegration of the euro would do to gold (I believe it would be overwhelmingly bullish) and what a hard landing or bust in China would do (now, that would be devastating for gold, even if only for a while.)
A nimble trader's dream for gold in 2011 would be as follows:
1. China remains slow and frightened in fighting inflation for now. Further, there is only a modest correction for U.S. stocks and other risk assets. Gold peaks in early 2011 between 1,500 and $1,600 per ounce.
2. A growth shock finally does hit China. Gold plunges back down toward $1000 per ounce, as other commodities crater and the U.S. dollar soars.
3. Unrest in Ireland and an overdue political and legal rebellion in Germany cause the European Commission to acknowledge that the only way to save the euro is to start casting some members adrift. Confusion reigns. The U.S. dollar soars even higher; initially, gold continues its descent. Soon, however, the news is that several European banks (and millions of their citizens and investors) have joined China in being big net purchasers of gold. Having slumped below $1000 per ounce, gold rockets higher.
4. These messes elsewhere having become old news, traders turn their attention anew to America's own intractable problems. As in late 2010, this will cause those who fled to Treasury bonds to get queasy and start selling. Ditto for the U.S. dollar. With no other refuge left of a monetary nature to go to other than gold, the next--and potentially most explosive--stage of gold's long bull market will be at hand. The trajectory of the next big move higher will be determined by to what extent America becomes unable to keep all the financial/fiscal balls in the air; and how quickly a more substantial devaluation of the currency materializes.
Happy NewYear!