Investing Outlook for 2011

Ok, I am the first to admit that really any forecast that goes out beyond 3 months, is really pretty worthless. That said, dont stop reading! I do think it makes sense to re-evaluate the markets at year end, come up with some possibilities for next year, and do a little handicapping.

So, first of all here are some of the risk factors we face next year. Some of these we have seen warning signs in the markets. Some of these are arguably not likely in 2011:

1. Municipal bond market: There is a real possiblity that someone will default next year and scare the heck out of the markets. California faces a $25BB budget shortfall in 2011, Harrisburg PA nearly defaulted on their bonds, and the Build America Bond tax subsidies are expiring. Spreads are widening, and, unlike the Federal Govt, states are required to balance their budgets every year. If a state goes, will the Feds bail them out? I assume so but getting there will be ugly.

2. Spain: while the ECB (European Central Bank) just bailed out Ireland and Greece, Spain could be next. And while Greece is roughly the size of Mississippi's economy ($300BB in GDP), Spain is 5 times bigger. Its the 9th biggest economy in the world. I think a crisis is possible, but they may survive until 2012 or even 2013 without a bailout. The problem is Germany has vowed they WON'T bail out Spain, although at some point, they likely will be forced to. More discussion of unwinding the Euro will ensue, fear and risk aversion always follow.

3. US Treasuries: Moody's put our gov's bonds on negative watch. That has never happened before, and usually means a downgrade within 12-18 months. Every time a European soveriegn was downgraded this year, it wasn't pretty. Even without a downgrade however, I have never seen so much media attention on our deficit problems (this is good). Rates spiking to 4.5-5% would not be good, however, for equities. I mean, everyone knows the value of a stock is the PV of its future cash flows right? What happens when you use a higher interest rate there? PEs fall....

4. China Breaks Down: There are a number of warning signals of a property bubble brewing in China. Real estate prices in Beijing and Shanghai are up 50-100%. Cost of a starter housing in Beijing an hour from downtown, cost 10x average salaries there! In late 2008-2009, the Chinese government forced banks to lend a TRILLION dollars, many loans of which are starting to show signs of stress (NPL's are up, non performing loans). In response, the Chinese govt will likely raise capital requirement next year, meaning less lending, less spending, slower growth. A major bust in China would be terrible for the markets.

So, similar to 2010, I think we'll see a smattering of crises. The odds of that are very high. Barron's panel of experts (at one point I was part of their surveys!), suggests the market will be up 11% next year. S&P earnings per share are running $85/share on a trailing basis. That is a 15 PE ratio. Next year, expectations are for 93/share, gains of 9%. So, yes I think the best and most likely case is that we'll trade up around 10% in 2011.

However, does that make me want to run out and buy stocks? Not really. We saw a low of 12.7x PE's this year back in June, and today we are at the high's (15x). Nowhere in the world have we addressed the solvency issues facing all the G20 borrowers of the world. All we have done is fix liquidity problems with government backstops and printing money. This day of reckoning is out there, and fears will at some point scare stocks this year. But we wont have to really face it for awhile (my bet is 2015 to 2020, financial armegeddon).

As far as the US and another recession, I don't think its likley. I suspect GDP grows slowly 2-3% , and the markets move upwards on the back of better earnings. Consumer savings rates & unemployment have stabilized in the US, meaning we wont see a major backup in consumer spending. Government stimulus is still on the table (now more with tax cuts). Dollar devaluation will continue with deficits (own GLD, or better yet, take a look at this fund, TPINX to get short the dollar).

So, net net, my plan is to wait for the inevitable dip, look for some good tech stocks (pick any big cap one), and put some capital to work. I'll keep you posted.

Good luck and happy holidays!