Why I See the Dow and Disposable Income Going Lower in 2011

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 |  Includes: DIA, IYR, KBE, XHB, XLF
by: Sanjeev Sharma

“An economist is someone who sees something that works in practice and wonders if it would work in theory.” - Ronald Reagan

The Dow crossed 11400 in November this year, as I had analyzed and predicted in the beginning of this year at Seeking Alpha.

The Dow (and the US Economy) might still go up for the first quarter of 2011. However, going forward from the second quarter of 2011, my analysis points me towards a lower Dow. Here are some of the factors:

Technical Analysis:

I did a technical analysis of the Dow’s historical data for my previous article - the Dow fell more than 40% only on 2 other previous occasions before the great recession – in 1938 and 1974. If we look at 2 years after the recovery started, the Dow had grown, but if we look at the 3rd year after the recovery started, the Dow had fallen from the year before. Since Recovery started in March 2009, I had analyzed that the Dow would grow for 2 years after that. However, on the basis of the same analysis, the Dow should start falling in the third year, after March 2011.

Disposable Incomes:

In one of my previous articles, I talked about the importance of disposable income for the US economy, and had used it to identify both the beginning and the end of last recession. High disposable income is one of the important factors contributing to the growth of the consumer based economy of the United States and is based on the concept of high wages for services of individuals. High disposable incomes help consumers purchase the excess inventory of cheap finished goods and creates a demand for new types of goods and services. I do not believe high disposable income has anything to do with productivity, it is simply a matter of what society thinks is the value of a person’s work (for example, Artisans and craftsmen migrated from Europe to the US in the last century as they could get paid higher wages in the US - they mostly did the same work as before). Higher wages do not necessarily increase inflation, as long as the supply of available goods is higher than the demand.

The following factors are now threatening to lower the disposable incomes again in 2011:

- Wages: Private sector wages are still restrained from growing due to high unemployment, outsourcing, technology and globalization. Though Public sector/Government employees were protected and were getting wage increases, a recent federal government order has restrained that too. With 70% of the US economy in the service sector, a wage increase/higher charge for services is important for the economy to grow.

- Higher Interest Rates: As money has been moving out of the Bond markets, Interest Rates have again started going up and would impact peoples' budgets.

- Oil prices: Oil prices have steadily been increasing in 2010 and due to global demand, may continue in 2011 also.

- Commodity Products : The recent Onion crisis in India tells me that that there will be Inflation in food and commodities due to demand from the developing countries, and will impact disposable incomes in 2011.

High Unemployment: Unemployment does not seem to be going down due to the following factors:

- Housing Market: The housing market is a large employer in United States. Stable and increasing home prices helps build consumer confidence and encourages people to spend and invest in renovating and purchasing houses. Home Prices in the US bottomed out in the middle of 2009 and grew in 2010 for some time. 2010 saw a brisk activity in homebuyers looking for foreclosure properties for many months. However, the issue of Robo-signatures at Banks and a non-clear government policy about the legal status of the purchase of such foreclosure properties has now slowed that clearing process.

- Bank Lending and New Projects: Though the Fed has enabled the banks to give loans, banks do not find enough viable projects for lending, and though there is a pent-up demand among homebuyers, the banks are overcautious about that sector and are still not lending fast enough.

- Crisis in US Municipalities and States: Something unusual happened in the last decade: while government organizations continued giving salary raises to employees, the salaries of private sector employees did not grow much due to outsourcing, globalization and technology. An imbalance has been created in the budgets of government organizations and the capacity of private citizens to pay for these budgets. Municipalities and State governments have been forced to either layoff government employees or use new laws and ways to collect taxes from commercial organizations and individuals. These new taxes and requirements has been further eroding the attractiveness of investing in the United States by corporations and individuals.

- Absence of new Technologies: Traditionally, the US economy and employment rides on new technologies (the last one being the IT and Telecom technologies of the 1990s). Except green technologies, which are yet to add meaningfully to employment numbers, no other new technologies are on the horizon. The new tax rules by government to encourage industry investment in R&D would help, but it has a long gestation period.

On the positive side, the government has the capacity to intervene in some of these factors and the President looking for a second term might change things aggressively to grow the economy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.