Market Predictions for 2011

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 |  Includes: BBVA, DB, SAN, UBS
by: Michael Shulman

Everyone has written a forecast. In the spirit of starting the new year modestly, the other guys pretty much have it wrong, basing their projections on a month of data, perhaps three months and not underlying trends. My thoughts on 2011:

  • The Economy: It will sputter, grow a bit in Q1 and Q2 and then the double dip begins, at least in the real world. It all begins and ends with housing. Housing starts are about one fourth of what they were at the top of the bubble and less than one half of where they were at the bottom of previous housing recessions. Prices are falling and will fall nationally all year as defaults and foreclosures accelerate and add to inventory. There are no catalysts for growth other than “animal spirits” and credit that is loosening from unspeakably tight to very tight. Real world unemployment – including work force dropouts, part timers, the discouraged and those retired or “disabled” to collect some income – is north of 20%. Government spending is contracting almost everywhere. Winners: traders as liquidity from the Fed keeps flowing, gold, silver, oil and other commodities used to hedge the dollar. Losers: corporate profits in the second half of the year, led by the banks. Speaking of the banks …

  • The Banks: Getting better, eh? Please put in place 2007 accounting standards for asset valuation – mark-to-market accounting on most things, year by year valuation of the underlying collateral for commercial real estate mortgages – and you have a busted banking system. Ben Bernanke, the citizen and politician, stays awake at night thinking about unemployment and the economy. Ben Bernanke the chairman of the Fed stays awake at night worried about the banks and the half trillion to trillion dollar hole in their balance sheet, not to mention the tightening of capital standards. And he knows he cannot rescue or bailout a failing big bank – politics dictates he must let them fail, on some fashion and the FDIC cannot save, on its own, any of the big banks. The answer is more liquidity and the support of spreads that led the banks heal themselves. The process will be done in about four to five years. Winners: again, liquidity driven-trades in commodities. Losers: the big banks, although, since they are too big to fail, the downside is limited up until there is a crisis. That is here. European banks, however, are another story ...

  • Europe: A mess getting messier, I am headed there in three weeks to see what is going on. The governments are broke; austerity will not assuage bond markets; the ECB and the rescue fund can keep headlines moving until Spain’s private sector banks, led by the caja or regional banks now totally wrecked from bad real estate loans, go boom. There is not enough money to save Spain. And the Germans, while having looked in the mirror and said, "Okay, we will pay some more to keep the EU and the euro alive," can only do so much for political and constitutional reasons, a constitutional amendment forcing them to tighten and tighten some more in the next three years. Bottom line: more crises and more headline management. Eventually the ECB will print money, probably before a German takes over in mid summer. Winners: European exporters, liquidity traders doing commodities and precious metals, the dollar. Losers: the euro, the big European banks such as DB, STD, BBVA and UBS. The exporters, outside of Germany, will do little for their national economies even if the great mythic figure of China keeps importing stuff. Speaking of China ...

  • China: Talk about a mess getting messier. When all is said and done, their bubble will make Japan’s seem smaller, and I lived in Tokyo when the Nikkei flirted with 40,000 and Japan and Japanese business practices were going to conquer the world. Didn’t work out, did it? Check out my recent piece, “Five Reasons to Hate China,” the bottom line is China is going to slow, sputter, fight contraction, then slowly or quickly blow up. Gotta be. Traders say no, the dictators will not let it happen. Sorry, they cannot arrest everyone who disobeys the Pollituro. Winners: day traders in the FXI and legendary short sellers Jim Chanos and Mark Hart, both seriously short China. Losers: day traders in the FXI. A potential catalyst is a serious trade “issue” – call it the opening salvo in a trade war with China, something long overdue if you actually read Adam Smith before you quote him. Speaking of trade wars and U.S. politics …

  • U.S. Politics: One of the few things Congress will be able to agree on other than a Sarah Palin candidacy will be a boon for Comedy Central, is to beat up on China. Everyone, that is, who is not governing but simply talking, legislating and perpetually running for office. Congress will not agree on too much else. Oh, maybe some health care cost containment. House Republicans will have to placate Tea Partiers for three to six months before the Tea party guys want funds for the 2012 elections from the party, and through Q1 and Q2 everything will be about ideology and a misreading of the Constitution on Capitol Hill. Around summertime Republican leadership will be tired of being lectured by the newly elected and some work might get done, in part because the economy will be stuttering and sputtering again. In the fall, a stimulus in name only will be passed – probably in the form of tax reform. That’s about it. Oh, yes, Tea Party types and some others will refuse to fund Obamacare and have symbolic votes to repeal it and may even squawk about raising the debt ceiling. But John Boehner was around when Tom Daschle maneuvered Newt Gingrich into shutting the government down prompting a massive Democratic resurgence in 1996 and he will not let this happen again. If somehow the nutters refuse to raise the debt ceiling and the government is shut down, the public will go nuts and Obama will win fifty two states in 2012. Posturing is one thing; refusing to pay bills and honor Treasuries is a wholly different matter. Bottom line: Washington will generate a great deal of headlines but little of real meaning. Winners: advertisers on Fox, day traders. Losers: the American people, the economy and if things get out of hand with the debt, the Republicans. Oh, another loser is the regulated health care industry, Everyone hates their providers, they will take a beating on the Hill in 2011 and both sides of the aisle will make some form of cost control a meaningful issue. Most of this will happen within a regulatory framework outside of the public eye and few Congressmen understand. Big Pharma will probably take the biggest hit.

Bottom Line: with near 97% correlation among stocks, it is about trading, trading headlines and ignoring fundamentals as long as possible. The market will not be a six week prognosticator as it has been in recent decades but a six week prognosticator in perhaps six days. The positions I recommend in my service are all longer term so fundamentals can catch up with the traders. They do, however, catch up. Overall, no real housing rebound and no economic rebound. This will all become clear in the second half of the year.