2011 is going to be a year of contrasts—developed vs. developing, stimulus vs. tightening, spending vs. austerity, and bubbles vs. ranges. Nearly everywhere we look we find opposing extremes. Same goes for our 2011 Outlook. Whether looking at the US, Developing Markets or Europe, there are frictions within each market as well as across markets that gives us cause for concern. While we are beginning the year fully invested in all of our Model Portfolios, we feel that markets particularly equities could be nearing a top.
Within the United States, equities ended the year at fresh 2-year highs and investor sentiment, as gauged by the Investors Intelligence Advisors Sentiment Survey, posted its highest reading of bullish sentiment in several years. However, despite these green lights we see red. Typically, sentiment extremes are a contrarian indicator and often signal the top or bottom. Furthermore, credit default swaps on US municipals debt, which are bonds issued by US cities or other local governments, are widening, which means that professional investors are starting to bet that some states may need to be bailed out by the federal government. But with what money? We are watching the situation closely as it will have a significant impact not only on Municipal Bonds and US Treasuries, but also on the US and Global economic outlook. For the time being however, it seems that the combination of Fed stimulus in the form of QE2 and the Bush tax cut extension will lift US growth expectations and the equities markets for the foreseeable future.
In stark contrast to the developed countries, many of the developing countries, particularly China, Chile and Brazil, are trying to cool growth and tame inflation by tightening their monetary policies. If done too quickly or in the wrong way (overly strict capital controls) then this could have a hugely negative impact on rising commodities prices, developing equities markets as well as commodity producing countries such-as Australia and Canada. With that said we continue to like developing markets, particularly some of the smaller countries, such-as Chile, Colombia, Egypt, Argentina, and Peru. We think these countries will benefit as investors chase returns.
And then there is Europe. Europe is following a completely different path. Where the US is applying the gas to in theory build escape velocity from the economic slowdown and the developing countries are applying the brakes to prevent overheating and runaway inflation, Europe is doing neither. Europe appears to be stuck in neutral, while representatives from different constituent countries argue over the best way to solve their sovereign debt issues. Europe has a serious dilemma in that the core of the region is relatively strong while the periphery is weak. This means that it will be nearly impossible to create a solution that addresses the growth issues in countries like Ireland and Spain, while at the same time maintains the fiscal discipline that Germany demands. As such, we are completely avoiding Europe until there is more clarity around the situation.
Bottom line: A lot of diverging and conflicting signals often mean that something big is around the corner. We are fully invested now but anticipate turbulence ahead and could easily see reducing exposure across the board (equities, fixed income and commodities) within the year. See 2011 Outlook table for a quick snapshot of our views on various markets.
On a lighter note (pun intended) there is an article in The Economist’s “The World In 2011” on the global population. In 2011 the population is expected to reach 7 billion up from 6.1 in 2000 and 1 in 1800. 7 billion! The main point of the article is that we shouldn’t worry because the rate of population growth is slowing. But 7 billion people seems like a lot to me. 7 billion of anything seems like a lot. 7 billion ants … no thanks! 7 billion pennies … yes please! (But wait where am I going to put them all?)
I am not an “Armageddon is coming” type person, but It is easy to let your mind get carried away when you think of how much food, energy, water, etc. 7 billion people need. For The Economist article please see “Another year, another billion”. For a not so educated spin on the same topic please see “Ashton Kutcher Preparing For Armageddon”.
Happy New Year (7 billion times)!
James & Adam
Disclosure: I am long JJA, JJP, PXR, TIP, AMJ, EMB, IEF, PHB, IVV, EEM, FRN.