10 Reasons Why 2011 Will Be a Tough Slog

Includes: DIA, QQQ, SPY, TBT, VXX
by: Bret Jensen

The markets have had a nice rally this month, and we may have a bit further to go as the coming midterms have investors excited that there will be a major shift in Congress in less than two months. However, regardless of the election outcome; 2011 is likely to be a tough slog for the following reasons:

1. One thing the elections will not change is that taxes are going up in 2011. If nothing else, taxes on the “rich” will rise at the Federal level. Capital gains and dividend taxes will also rise. What’s more, taxes will go up even more at the state level given the dire state of their budgets.

2. Earnings estimates for 2011 will continue their trend of the last few months and will be revised still lower as analysts factor in much slower economic growth than was projected six months ago.

3. Job growth, especially at the small business level; will be anemic. This can’t be overstated. We have either ignored or punished the small business sector since this administration took office. The likely tax hikes on the rich will prevent small businesses from hiring (those making over 250K own small businesses that produce 48% of overall small business revenues). In addition, the looming small business costs of Obamacare make any business with over 50 employees wary of future employee costs.

4. Any boost provided by the Federal “Stimulus” will be much less in 2011 than 2010. Even though the overall Stimulus package was poorly targeted and produced little real job creation, it did dump hundreds of billions into the economy. Mostly it temporarily glossed over the need for states to make structural changes in their unionized workforces and social programs. As stimulus fades, the layoffs and restructurings that were postponed will now need to be made; which will provide a major headwind to overall job growth in 2011.

5. Although investors are currently cheering the coming realignment in Congress, especially the resulting death of Cap and Trade, Card Check, etc…I believe they are overestimating the benefits of a divided government given the dire state of the economy. This is not 1994 when the underlying economy was in a much stronger position. In addition, President Obama does not have the pragmatism or managerial experience that President Clinton provided. Neither do the Republicans have a well crafted plan or experienced leadership (Gingrich, Armey, Graham, etc..) like they did in 1994. The result likely with be more partisan warfare and acrimony as the President seeks more comfort in his base on the left, and Republicans see no reason to compromise leading to the presidential election of 2012. Expect more filibusters and backdoor appointments like Elizabeth Warren as well as more business vilification. Obviously this will not be good for the overall business climate, hiring, or economic growth.

6. The housing market will not rebound in 2011. Despite record low interest rates and a myriad of government assistance programs, housing is a disaster and will remain so until the market is allowed to find its natural floor. Expect more foreclosures, housing price declines, and additional hapless government housing programs and policies in 2011. Meanwhile, Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) have not been addressed as the government has just shifted risk to the FHA.

7. One of the PIGS will implode in 2011. The obvious candidates are Greece or Ireland given their economic contractions, deep austerity measures, levels of debt and poor growth prospects. Fortunately, either of these would be manageable given their meager contributions to European GDP. However, watch out for Spain. They have 20% unemployment, six times the vacant houses per capita as the United States, and a banking system (AKA, the Cajas) that is teetering on the edge. Spain contributes 11% to European GDP, and if they go; the whole worldwide economic system will feel the impact.

8. Given the anemic and likely to be long-lasting slow worldwide economic growth; currency interventions and trade tensions are likely to rise and could assume a momentum of their own with unintended consequences for worldwide trade and economic growth. You can already see signs of this in the recent Yen intervention, escalating trade tensions with China at the Treasury and U.S. Congress, and tit for tat trade disputes at the WTO between Boeing (NYSE:BA) and Airbus.

9. China has a property market bubble that will eventually pop. This will probably happen despite measures to restrict real estate lending. There are two statistics that I believe already point to the fact it might be too late. (1) The medium residential unit is Beijing is 27 times median population income. (2) According to analysis based on electricity usage, there are 65 million vacant housing units throughout China.

10. Given the unprecedented and continuing measures taken by the government since the economic crisis, we are likely to have at least one “hiccup” in 2011 caused by either deflationary or inflationary fears. This will cause at least a 15-20% correction in the market sometime in 2011.

Given our outlook and uncertainty for economic growth, two ideas we are playing right now are selling out of the money puts on the TBT and VXX to build a substantial position in these instruments at these levels. We believe these will be useful hedges at some point in 2011. Be careful out there.

Disclosure: Long VXX and TBT