As Mark Twain once said, “History doesn’t repeat itself, but it does rhyme.” If you agree with the estimable Mr. Twain, then a combination of:
- Investor sentiment near all-time highs,
- The paucity of analysts forecasting anything but rosy times in 2011,
- An unusual lack of volatility, and
- Complacency on the part of investors to the point of not even bothering to check prices, then…
This recent report from Citi’s research department on the prospects for 2011 makes for a chilling potential “rhyme” with some ugly past markets.
The table below comes from Citi, though I first saw it reproduced in an article at a website called lateralthinking.biz, to whom I give full credit. Quoting from the Citi analysts:
Over the course of this year we have constantly referred to what are the only three market overlays we think fit with the current price action in the stock market. Our favorite for some time has been the spooky chart of 1929-1939, which we have been watching since 2003. A very close second--but fast becoming a potential number 1 choice--has been the overlay of 1966-1976. And a relatively distant third has been the chart of the 1906-1909 period.
It is these charts that have led us… to surmise that 2011 will not be a good year for the stock market.
Citi’s analysts continue:
Bottom line: Our favorite overlays suggest for the DJIA:
The market peak may be posted as early as the opening days of January, 2011 (possibly even January 3 as per the other three examples) with a down January in the region of 5%.
We will see an intra-year bear market next year (a decline of more than 20%).
We will close the year down double-digit percentages (approx. 16%).
What will that catalyst be? Likely one of two things:
The bond market falling sharply as it did in 1977, sending yields higher and fuelling inflation, or supply fears, or both.
Europe imploding. While this could stress our positive view on the dollar, fixed income, and commodities, this dynamic still supports our bearish equity view.
I don’t share their view that we must rhyme with the “spooky chart of 1929-1939,” but I share their concerns that most investors and almost every single analyst predicting 2011 are collectively whistling past the graveyard.
I believe the level of complacency right now is typical of lemmings following each other saying bemusedly, “Hey, where’s everybody going? And shouldn’t I be a part of it?”
Like Citi's analysts, I believe we will experience a pullback some time beginning in the first quarter. This will come as a disappointment to our clients and subscribers, as well as most Seeking Alpha readers, because we are, all of us, tired of this nonsense! We’re ready for a market we can invest in and leave our funds in without having to watch it like a hawk or trade in and out of.
We’re close, I believe – but not quite there yet. This kind of complacency demands at least one more shakeout. But where I part company with Citi’s scenario is 2011 after a lesser shakeout has run its course. Even if they are correct and the market were to plunge 20% -- a scary ride for those 100% invested – I think it will recover along with the US and global economy. Ireland, Greece, and US home sales get all the headlines right now, but other nations and other sectors of the US economy are both undergoing upward revisions, increased sales, lower costs, higher quality, etc. These are the inevitable results of economic recessions. Stock markets? Their machinations are considerably harder to predict!
If Citi is correct, what would 2011 look like? You don’t have to imagine it. My friend and competitor Sy Harding at streetsmartreport.com has drawn the following chart of the years 1938-1940, which history shows does bear an uncanny resemblance to 2009 to 2010 and which Citi believes will likely play out in 2011 in the same way it did in 1940. Here is Sy’s chart: (In Citi’s view 1937=2008, 1938=2009, 1939=2010, and 1940=2011…)
Does this look a lot like 2009? 2010 ? 2011 ???
If history were to rhyme “exactly” you should expect a Dow that drops to 9000 or so by mid-2011, then a partial recovery that leaves the markets still down for the year.
My own expectation is not so dire, but I am, wearily and reluctantly, and for all the reasons I mentioned above, once more raising cash for our own and our clients’ portfolios. That way, whether I am correct or Citi is correct, we will have the cash to be a buyer when the shakeout, whatever its amplitude and duration, occurs. Unlike Citi's analysts, I believe that 2011 will most likely finish higher, not lower, for the year. Even more importantly, I recognize that we are still not yet back in that precious stage where we can afford to be complacent buy-and-hold investors.
Like many of you, I look forward to a return to the days when my clients don’t wonder why I am “trading” so much. I hate to trade; I love to buy quality and hold it. But I will do what I must to protect our clients’ assets in what I imagine will be a difficult time. Then I will be able to buy, hold and spend at least part of my days on more important pursuits like writing books, skiing, SCUBA diving and hiking. But not until then…
Disclosure: Much as we hate to, the level of complacency and general outlook for the short term force us to once more raise our cash positions. We go into 2011 with more than 50% in cash. If/as the market does decline, either to Citi’s doomsday level or my more sanguine one, “the man with cash is King.”
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Past performance is no guarantee of future results, rather an obvious statement but clearly too often unheeded judging by the number of investors who buy the current #1 mutual fund only to watch it plummet next month.
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