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.
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.