My Framework For 2011

A few readers have asked me for predictions for 2011. I don't come into a year making predictions but rather with a framework on how I view the economy and the markets. During the year I use this framework in addition to short term considerations such as sentiment, seasonality, technicals(overbought and oversold) and valuation among other things to make investment decisions.

I believe we are currently in a cyclical recovery within a secular bear market. Normally, it is too early to look for a major turn less than two years into a cyclical recovery. However, given the unprecedented imbalances and stimulus we are seeing, I believe there is a much higher chance of the recovery being derailed than in a normal cycle.

 Among the largest risks I see are:
  • Unprecedented liquidity in the form of money printing leads to inflation or inflation is imported from countries like China. That leads central bankers to hit the brakes and results in higher rates.
  • China is trying to fight inflation and perform a "soft landing". The last time we heard the phrase "soft landing" was 2007 and before that was 2000. We all know how those worked out for markets. 
  •  European banking and/or sovereign crisis.
  • US municipal crisis or fiscal crisis. 
The economy is like a supertanker and rarely turns on a dime. In order to see a major turnaround I believe that a crisis will need to hit. But a crisis is a larger than average potential outcome, given the state of the World. I don't believe valuations are pricing in many problems and investors cannot afford to have anything go wrong.

To summarize my framework for 2011: the economy is unlikely to turn on a dime given that we are slightly less than two years into a recovery but an event that can derail it is a higher than normal potential outcome. Some were probably looking for a simpler answer like the market will be + or - 12%, but the market is not that simple.

6 comments:

PJ said...

Well, but we're already seeing inventories build up, apparently involuntarily. That normally happens just before the start of a recession.

This despite spending being above earnings, so that only unprecedented federal borrowing is maintaining spending and the savings rate keeps declining and is too low to support the looming retirement of the baby boomers.

Economic sentiment is as optimistic as stock market sentiment, and that is supporting the economy, but at the cost of future spending. It looks like GDP has gotten ahead of itself a bit and is likely to soon pull back.

Anonymous said...

The market will be down 25.52% next year.

Good luck to all,

JD

Anonymous said...

Not necessarily useful for short term traders but still very insightful when looking at the big picture...

http://www.contraryinvestor.com/mo.htm

JD

Revelo said...

"I don't believe valuations are pricing in many problems and investors cannot afford to have anything go wrong."

This pretty much sums up my view. Always have a margin of safety was Graham's view, and right now there is no margin of safety in stocks.

I'm staying in intermediate-term corporate bonds for now, looking to transition to intermediate-term munis on price weakness there. I don't have the stomach for long-term bonds, but they will probably do very well if we sink into a Japan-style long deflation, which is where I believe the whole world is heading.

Anonymous said...

gold will be the last bubble. once that pops and the world enters dark ages for years, that will spurn the real recovery. the "stuff" first needs to turn into compost. 2011 will most likely be an up year tho

Anonymous said...

"China is trying to fight inflation and perform a "soft landing". The last time we heard the phrase "soft landing" was 2007 and before that was 2000. We all know how those worked out for markets. "

This is a currency war. There is no real inflation. There is engineered inflating of asset classes to bailflate the USA and it's excrement side effects being exported to the Chinese which they aren't liking much.