Tuesday, January 11, 2011

2011 forecast from Paul Schatz

Paul is a top notch analyst, money manager and friend. All opinions expressed in his articles are his, and do not reflect any recommendations to buy or sell securities, options, currencies, futures or any other financial instrument not specifically mentioned.

One of the most worthless yet enjoyable topics of the year is the pundits annual forecast. An unusual amount of time is spent discussing this in the media, but after January, no one ever reviews again nor seems to care. I usually end December with an idea of what I see ahead and then adjust according to how many others agree with me. As longtime readers know, I don't like to be in the majority as that group is typically wrong.

Before I get to my forecast, which is not my annual "Shockers" list due out later this month, let's do a quick review of what I envisioned for 2010.

Stock market - I thought we would see a generally flat market, somewhere between -5% and +5%, not the 15% we so gladly enjoyed! I thought the April peak would stand for the year. Stocks did go higher at the end of the year, but that call was pretty much correct. I forecasted a double digit decline, but thought it would unfold in Q4. We saw a 16% hit during the summer.

Long-term treasuries - would be a surprise leading asset class. They actually melted up through August and then melted down through November, finishing up 9%.

Dollar - I was bullish the dollar in 2010 and it gained a whopping 1.37%.

Gold - I was positive on gold and it gained 29%.

Inflation - It's been the same forecast for 2010, 2009, and 2008. Inflation remains under wraps and not problematic.

Economy - I thought GDP would hang in above 0% during the first half and slip back into negative territory later in the year. I was right on the first part, but wrong on the second part.

Bernanke & Co. - Short-term rates would not be touched in 2010 and they are still in the same spot as they were 12 months ago.

So now, let's get to my forecast for 2011. The sooner I get it out there, the sooner I can be proven wrong! As always, I had a lot of fun thinking about it and creating it, although it has no bearing on how we manage money for our clients.

Stock market - We are now in the 3rd year of Obama's term (presidential cycle) and traditionally, it's the most bullish of all with an average return of 17% and only one down year in the past 70 years. When you examine the stock market decade by decade (decennial pattern), you find that the first few years of the decade tend perform worse than later in the decade. That's two nice contradicting pieces.

Let's add the almost uniformly bullish predictions from Wall Street into the mix with the average strategist forecasting double digit returns. USA Today ran a front page piece last month with the headline "5 Wall Street Heavyweights Say It's Time To Get Back Into Stocks".

Even former Merrill Lynch honcho and usually skeptical Richard Bernstein sees a 15-20% return for stocks. That's shocking and worrisome! Can it be that easy? I have research dating back to 1990 and that group has been uniformly wrong roughly 75% of the time, although they hit the bulls eye in 2010. Kudos!

For 2011, I think the stock market will end the year modestly in the black, but only in the mid single digits. I envision corrective behavior in the spring with a more significant correction in late summer to fall. I haven't done enough sector work yet, but given that almost everyone hates healthcare and utilities, I'll take those two sectors as winners in 2011.

Long-term treasuries - After attempting to rally in Q1, bonds resume their slide during the first quarter and into Q2, but firm up during the second half of 2011.

Dollar - I remain bullish on the greenback over the long-term, even if we see another selling wave back to the old lows. Ultimately, I think the dollar index will hit 100 and the euro will slide back below 100 on its way to oblivion.

Gold - Clearly, after back to back strong years, gold is due for some pause to digest, in the short, intermediate and long-term. That can take shape in many ways. I think 2011 will bring a significant increase in volatility and I would not be surprised to see a $100 down day during the year. When all is said and done, I believe we will see at least $1500 hit during the first half of the year, but not another vertical assault like we saw in 2009 and 2010. Based on history, the year should end up with modest single digit returns, best case scenario, but outperforming its cousin, silver. Should that roadmap unfold anywhere close, that could set the stage for a monster blow off to the upside in 2012. But that's getting laughably ahead of myself.

Inflation - Unlike the past few years, I see headline inflation percolating a bit, especially during the first half of the year, but the core (excluding food and energy) remaining tame.

Economy - If this was a "normal" recovery, GDP should explode higher this year, but especially during the second and third quarters. I just can't subscribe to the "normal" recovery theme. The economy has been juiced with free and easy money for years and once that spigot is turned off, similar to what FDR did in 1937, I believe we are in for trouble.

Thankfully, Congress learned from their predecessors' mistakes in 1937 and did not allow taxes to increase in 2011. In fact, by cutting the payroll tax for 2011 and 2012 by two full percentage points, I have to upgrade my take on the economy to a better than just plodding along at 2%. Don't underestimate how much not raising income taxes and cutting payroll taxes will do for the economy and markets!

Federal Reserve - As the voting members of the FOMC turnover, expect the Fed to mirror Washington and get stuck in gridlock. Bernanke loses some internal power with Kevin Warsh sliding more towards the hawkish side and Plosser and Fischer coming back to dissent and push a more neutral stance once QE2 runs out by June. Keep a close eye on the two year note as the markets may force Bernanke's hand later in 2011 to take action he clearly won't want to take.

Unemployment - Sadly, the jobless recovery continues and unemployment stays stubbornly elevated above 8.75%. I think it's going to take a second recession to cleanse the system and get put unemployment on a path back to 6% or lower sometime later this decade.

Natural Gas - Surprise! Surprise! Finally, the bulls take control and natural gas ends up as one of the top performing assets of the 2011.

So that's it. Another fearless forecast in the books. I may add some items next Friday as I continue to read, research and digest, but I think you get the picture. As always, I am eager to hear to your comments. Please don't be shy about emailing me!

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