It is the season of prognostications in the investments profession, but I will refrain from hazarding any guesses about how 2011 will turn out. As we enter the new year, the bull market that began in March 2009 is clearly intact. It is hard to find anyone who is not optimistic about stocks through at least the first half of 2011. Yet, it remains a crisis-prone environment, both at home and abroad, so I prefer to take it one month at a time and be prepared for a wide range of possible 2011 outcomes. Investors face the dilemma of short-term stock market conditions that are positive but artificial due to unsustainable government policies, and must keep a watchful eye on the horizon for signs of the next, inevitable crisis.
There are so many moving parts to the risk equation that investors cannot hope to have a sure method of knowing when to cut risk exposure. That is why holding above-average cash, despite its negative after-inflation returns, is not an unwise asset allocation decision.
The consensus outlook for another year of double-digit stock market returns in 2011 is understandable:
- The economy appears to be gaining some momentum (though it is impossible to gauge the sustainability of an economic recovery that is dominated by government spending).
- The Fed is openly targeting higher stock prices, and making cash and bond market alternatives unattractive.
- Retail investors have begun to shift money back into equities, after favoring bonds for the past three years, which could become a self-reinforcing cycle that sustains the uptrend in stocks.
- Technically, the stock market looks very healthy, given the recent breakouts to new highs, powerful momentum, and broad upside participation across all sectors and market cap segments. There is no sign yet of the technical divergences and non-confirmations that typically precede important market peaks.
