Five Predictions and Four Potential Surprises for 2011

 |  Includes: DAX-OLD, SPY
by: Sean Hannon

After reviewing my 2010 predictions, I now look ahead to 2011. For this article I will outline five predictions for the year ahead as well as four potential surprises that could debunk my theses. Doing so will allow the reader to consider both angles of the argument - a practice we should all adhere to as investors. As always, as my views change, I will update subscribers through the weekly newsletter, bonus articles and weekly commentaries. Even when we are adamant about future events, we must remain flexible and be prepared to alter our opinions when new information emerges.

My five key predictions are as follows:

  1. Economic Surge - Parsing the economic news produces uncertainty. Employment and housing remain weak while other areas point to growth. Pushing the data through an econometric model, many expect a year of higher, but unspectacular growth. However, the stock market offers a different view. As a forward indicator, global markets are marching to synchronized highs. Partially attributable to high liquidity, I believe the markets are discounting future economic growth, which will tower over even the most bullish forecasts.
  2. Markets Cheap - This is a more bullish retake of last year’s forecast. With a fair value target for the S&P 500 of 1,400, the market starts the year at its largest discount to fair value since 1997. While not expecting a repeat of 1997’s 32% rally, the current backdrop is favorable. A rally to fair value would deliver double-digit returns, thus making current prices a good buying point.
  3. Inflation Debate - The great debate rages. As the Federal Reserve (Fed) keeps interest rates low and pushes additional money into the economy via quantitative easing (QE), many believe an inflation surge is coming. Others, including the Fed, think the current easing can be unwound quickly and contain any inflationary spike. Thus far, the debate is a draw. Increasing commodity prices signal inflation, yet headline numbers do not. I expect this dichotomy to continue. So, 2011 will see commodities move higher, but weakness in housing and consumer prices will keep headline numbers in check. For those looking for a decisive verdict, the wait continues.
  4. 1990s Redux - Those investing during the tech bubble followed a simple rule to large gains. Buying the dips and riding the eventual rally was a simple, yet profitable plan. In 2011 it will be as well. We will see dips during the year (I am on record calling for a sharp January decline), but the trend is higher. Patiently buy dips and profits will come.
  5. Mean Reversion - 2010 is ending with synchronized highs, but looking at annual returns proves interesting. North American, British, German and Russian markets will post double digit returns, but French, Japanese, Australian and Brazilian markets will finish negative or flat. For 2011, expect this to reverse. Those lagging markets will quickly close the performance gap and outperform 2010’s leaders.

Although I’m confident in these predictions, I always present a counter-argument. These four surprises, which I consider unlikely, could derail my predictions:

  1. Stock Picker’s Market - Most pundits continue touting the need to pick the right stock. Although a believer in active management, 2011 will be a year in which those owning index funds will prosper.
  2. No Pullback - There is a chance that a pure vertical ascent without at least a 5% pullback is possible, but I find it unlikely.
  3. Fed Increases Rates - increasing interest rates would be a shock that puts both the economic recovery and the market’s rally in jeopardy.
  4. Bear Roars - Some still believe we are seeing a temporary rally in an ongoing bear market. Not among the group, I feel markets remain bullish.

Summarizing all these ideas, I believe 2011 will provide great returns. Those who trade around evolving developments will prosper, but so will those who are patient enough to ride the trend higher. Over the coming year, I hope to be on both sides of this trade - tactically trading with new development while allowing our core holdings to deliver tremendous gains.