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2011: More Questions Than Answers?

by Gary D. Halbert
January 4, 2011


1.  More Questions Than Answers in the New Year

2.  Long-Term Interest Rates: Correction or New Trend?

3.  “A Fed-Induced Speculative Blowoff” by John Hussman

4.  Will US Stocks Continue Higher in 2011?

5.  Just Getting Back to Breakeven


The holidays are over and the New Year has begun.  Looking back at 2010, we see that the US economy performed slightly better than most expectations, and we did not fall back into a double-dip recession as many feared.  Likewise, the US equity markets performed better than most expected, especially in the last several months, with the S&P 500 gaining almost 13% (excluding dividends) for the year.  Nevertheless, investors fled the US equity markets in droves last year for reasons that are still not entirely clear, with millions going into bonds and bond mutual funds.

Short-term interest rates have remained near zero since the middle of 2009.  Most forecasters predicted a year ago that the Fed would begin to raise short-term rates once the threat of another recession passed.  However, the slow economic growth and continued high unemployment caused the Fed to put a hold on plans to begin monetary tightening and, in fact, implemented another round of quantitative easing (QE2) that will last until mid-2011.

Interest rates on medium and long-dated Treasuries jumped rather significantly in the last several months of 2010, much to the surprise of millions of investors who shunned stocks and herded into bonds and bond funds in record numbers over the last year.  Home mortgage rates are up almost 1% from the lows, and this has implications for the housing market, as I will discuss later on.

Some speculate that the rise in long-term rates is due to inflation fears, what with the government running trillion-dollar deficits.  Others attribute the rise in long rates to the improved economic outlook for 2011.  This week, I will reprint a very interesting article on this debate over why long rates are rising as we go along.  At the end of the day, the question is whether long rates will continue to rise this year, and the answer is yet to be seen.

Speaking of questions, there are many more unanswered questions than there are answers as we begin the new year.  I will list some of the more important unanswered questions below.  As a result of all the uncertainty, the investment landscape is as blurry as ever for most people.  Millions of investors bailed out of the equity markets during the recession and credit crisis and never got back in and are fearful of getting back in now.  Many more who held on through the bear market cashed-out their equity holdings last year, basically saying, “forget the cheese, just let me out of the trap.”

Fortunately, there are professional strategies for dealing with uncertain markets.  Having the ability to move to the safety of cash (money market) and/or the ability to “hedge” long positions during bear markets is becoming more and more popular, while Wall Street’s traditional “buy-and-hold” approach is waning.

Halbert Wealth Management continues to search far and wide for successful money managers to recommend to our many clients all across the US.  There are several professional money managers we discovered in 2010 that we are quite excited about.  As soon as our extensive due diligence work is done, I hope to be able to introduce them to you in the coming weeks.

More Questions Than Answers

As we begin 2011, there are many more unanswered questions than answered ones.  Let me pose a few.  For starters, will the US economy grow by 3% or more in 2011?  As I have discussed often over the last couple of months, most forecasters have revised their economic predictions somewhat higher for 2011 in light of the Fed’s recent implementation of QE2, some better than expected reports and the extension of the Bush tax cuts.

On December 22, the Commerce Department released its final estimate of 3Q GDP which saw a rise from 2.5% in the previous estimate to 2.6% in the final report.  The final number was slightly below the pre-report consensus.  The 3Q number of 2.6% followed 1.7% in the 2Q, 3.7% in the 1Q and 5.0% in the 4Q of 2009.

Clearly, the economic recovery lost some steam in the middle of last year, which raised concerns that we might be headed for a double-dip recession.  However, several positive economic reports in November and December, a second round of QE by the Fed and the tax cut extension seem to have allayed many of these concerns as we begin the new year.

Among those were reports that holiday spending was the best in several years.  Total consumer spending (excluding autos) rose 5.5% to $584.3 billion from November 5 through December 24, compared with the same 50-day period a year ago, according to SpendingPulse.  This came despite an unexpected drop of 1.8% in the Consumer Confidence Index in December, as reported by the Commerce Department.  Retail sales for November also rose by a better than expected 0.8%, following 1.7% in October.  

Perhaps the best news of late came last Thursday when the Labor Department announced that initial claims for unemployment benefits fell to 388,000 for the week ended December 25.  This was the first reading below 400,000 for last year and was the lowest level since July 2008.

The US Leading Economic Index (LEI) rose a solid 1.1% in November.  It was the fifth consecutive monthly gain in the LEI and suggests the economy should continue to recover during at least the first half of this year.

Yesterday’s ISM manufacturing index rose less than expected in December to 57.0, but it marked the 17th consecutive month that the index was above 50, a level above which the manufacturing sector is expanding.

On the housing front, the latest figures were mixed.  Existing home sales for November were up slightly at 4.68 million units.  New home sales were also slightly higher at 290,000 units.  Yet home prices continue to edge lower in most parts of the country.  The median sales price of existing homes fell from near $185,000 to near $170,000 at the end of October according to the National Association of Realtors.

A massive overhang of unsold homes remains on the market.  As I have written previously, a large “shadow” inventory of foreclosed properties and soon-to-be-foreclosed homes will continue to add to the supply-demand imbalance.  However, most forecasters I read expect home prices to fall only about 10% more nationally in 2011.

And there may be some light at the end of the tunnel for the housing market, assuming lending picks up this year.  Housing starts have been averaging around 500,000 units a month.  500,000 units is half the level necessary just to keep up with population growth.  Meanwhile, home affordability measures such as price-to-rent ratios have improved significantly recently.

Of course, the recent increase in mortgage rates is a negative, but there is a good chance the housing market will bottom in the second half of 2011.  Home prices in California have rebounded 15-20% from their lows, and some other areas are already rebounding as well.

So that brings us back to the original question: Will the US economy grow by 3% or more in 2011?  I would venture that 80-90% of the forecasts I see are in the 2.8% to 3.5% for this year.  Some like Goldman Sachs see GDP growth of 4%, but those are rare.  I think the economy will struggle to reach 3% growth in the first half of this year.  If bank lending loosens up, then I think we could get above 3% in the second half, barring any new negative surprises.

Long-term Interest Rates: Correction or New Trend?

The next question is, will interest rates continue higher in 2011? In the last few months of 2010, I focused a lot on the surprise move up in rates on medium and long-term Treasuries and home mortgages.  There is still a great deal of confusion on why these rates went up significantly, especially with the Fed doing QE2 in a deliberate attempt to keep those same rates low.

Some believe it was a warning of higher inflation to come, while others believe it was due to the improvement in the economic outlook.  What follows are excerpts from the always-interesting Dr.  John Hussman, founder of the Hussman family of mutual funds, as he tries to sort out why rates went up:   

QUOTE: A Fed-Induced Speculative Blowoff

Why are Treasury yields rising despite hundreds of billions of Treasury purchases by the Federal Reserve? There are two possibilities in the current debate. One is that the Fed's policy of purchasing Treasuries has scared the willies out of the bond market on fears of higher inflation, and that the policy is a failure. The other is that the policy has been such a success at boosting the prospects for economic growth that interest rates are rising on anticipation of a better economy.

From our standpoint, neither of these explanations hold much water. On the inflation front, the recent bond selloff has hit TIPS prices as well as straight Treasuries, which isn't something you'd expect to see if inflation expectations were being destabilized. And although precious metals and other commodity prices have been pressed higher, the commodity run can be more accurately traced to negative real interest rates at the short-end of the maturity curve, coupled with a downward trend in long-term yields that has now reversed dramatically (more on that below). I've long argued that unproductive government spending and profligate fiscal policy are ultimately inflationary (regardless of how the spending is financed, and particularly if it is monetized), but I continue to view persistent inflation as a long-term, not near-term concern. A rise in T-bill yields of more than 15-25 basis points would change that assessment. Until then, velocity can be expected to collapse in direct proportion to changes in the monetary base, with little impact on prices.

As for the notion that the Fed's targeted Treasury purchases have directly aided the economy, the argument requires bizarre logical gymnastics. It demands one to believe that although the purchases were intended to stimulate the economy by lowering rates, they have been successful without lowering them, and in fact by raising them, because the expectation of lower rates was so stimulative that it caused rates to rise, so that the higher rates can be taken as evidence that lowering rates without lowering them was a success. Oh, brother.

It's clear that we've seen some firming in various indicators such as the Purchasing Managers Index, the ECRI Weekly Leading Index and weekly claims for unemployment. The question is whether these can be traced to lower yields and greater availability of liquidity. On the interest rate front, the answer is clearly no, as Treasury and mortgage rates are even higher than they were before QE2 was announced. On the "liquidity" front, the additional reserves have simply added to an existing pile of well over a trillion dollars of idle reserve balances in the banking system. And while we did see a pop in consumer credit in the latest report, it was entirely due to Federal loans to students (arguably people displaced from the labor force and seeking an alternative). Other forms of consumer credit have collapsed at an accelerating rate.

So neither side typically taken in the debate over the Fed's Treasury purchases is particularly satisfying. Fortunately for fans of logic, there is a third explanation that is much more plausible, and has the benefit of having data behind it. Despite my extreme criticism of Fed actions in recent years, I would argue that QE2 hasin fact been "successful" over the short-term, but not through any monetary mechanism. Rather, QE2 has been successful a) by creating a burst of enthusiasm that released some pent-up demand in the same way that Cash for Clunkers and the new homebuyer tax credit did, and b) by encouraging investors to believe that the Fed has provided a "backstop" for stocks and other risky assets, creating a speculative blowoff in these securities, to the detriment of what investors perceive as "safe" assets, which ironically includes Treasury securities.

In short, the main effect of QE2 has not been monetary but has instead been rhetorical - and that rhetoric may very well be nearly empty.

The key event related to QE2 wasn't its formal announcement, but was instead the Op-Ed piece that Ben Bernanke published a few days later in the Washington Post, which essentially advanced the argument that the Fed was targeting a "wealth effect" in stocks and other risky assets, in hopes of getting people to consume off of that perceived wealth. At that moment, Bernanke unleashed a speculative bubble in risky assets, and a selloff in safe ones. This has rewarded risk-seeking and punished risk-aversion, but it has also unfortunately driven the [stock] markets into an overvalued, overbought, overbullish, rising-yields condition that has historically ended in steep and abrupt losses.

Investors are chasing stocks with the greatest exposure to market fluctuations, commodities, credit risk, small-cap risk and volatility. Conversely, securities demonstrating reasonable valuation, stability, quality, or payout have been virtually abandoned by investors.  END QUOTE

As I’m sure it was obvious, Dr. Hussman believes that the US stock markets are overblown on the upside, with the S&P 500 Index having rallied over 85% from the recession lows under 700 in March 2009 to over 1,250 as this is written.  I couldn’t say that I disagree.

As for the next direction in medium and long-term interest rates, Dr. Hussman does not offer a specific prediction in the article above.  However, I will tell you that most forecasters I read do not expect that inflation will be a major problem in 2011, and therefore predict that medium and long-term interest rates will be in a trading range for most of 2011 and will not continue to ratchet up.  But don’t forget what I’ve always said, the bond market has a mind of its own!

Will US Stocks Continue Higher in 2011?

While Dr. Hussman believes strongly that stocks are overblown on the upside, and are well overdue for a significant downside correction, I must tell you that his views are in the minority.  Most forecasters I read believe that US equities will be higher again in 2011, and quite a number are now predicting that the major market indexes will reach new all-time highs this year.

DJIA Nearest Futures

With the US stock markets finishing 2010 on a strong note, there are a lot of historical statistics being floated around with predictions for 2011.  Here’s one such example:  According to the Stock Trader’s Almanac, the Dow Jones Industrial Average tends to gain about 50% from the mid-term election year low to the peak the following year, based on data going back to 1914.

The Dow’s low back in July of last year was 9,686.  Using the Almanac’s logic, the Dow should rise to at least 14,500 this year, thus reaching a new all-time high.  If that proved to be true (and I don’t think it will), it would mean that the Dow Jones has to gain almost 120% from the March 2009 low to get to 14,500 this year.  That would be quite a stretch, especially in a sluggish economy with continued high unemployment!

Just Getting Back to Breakeven

Obviously, no one knows if the Dow will make new highs this year (or any year).  If the Dow manages to get back to 14,000 this year, it will only mean that buy-and-hold investors are finally back to breakeven.  And that assumes that they held on during the severe bear market that saw the Dow shed almost 50% of its value in just over a year.

We know that many investors did not hold on through the bear market.  Based on data I have discussed over the last few months, millions of investors bailed out of stocks and stock mutual funds last year, even as the equity markets rose strongly.  Most market analysts are bewildered regarding why so many investors bailed out last year when the indexes were advancing strongly.  Here’s my theory based on what I hear people saying.

I believe than many of the formerly buy-and-hold devotees had their pants scared off in the bear market of late 2007 to early 2009.  A lot of people told me something along the lines of the following:

If the stock market ever gets back to the point that I can just break even,
I’m getting out, and then I’m done investing in stocks forever!

Obviously, I don’t have any facts or figures to back up this theory, but many investors have said this to me personally over the last few years.  If true, this would explain why so many investors cashed out of stocks and stock mutual funds in 2010. 

Unfortunately, many of these same people chose to reinvest in bonds and bond mutual funds at a time when interest rates were at historic lows.  With the recent surprise upswing in medium and long-term interest rates, most bonds and bond funds have lost money as well.

There is a wealth of research, including the Dalbar Studies that I have written about for years, which concludes that most investors are their own worst enemies.  They tend to buy and sell at the worst times, chasing hot returns that usually go cold soon thereafter.

This is precisely why I recommend turning the bulk of your investment portfolio over to professionals that have a time-tested systematic approach to investing that takes the emotion out of the decision making process.

These professional systems have the ability to move out of the market and sit in cash (money market), and/or they can “hedge” their long positions during market downturns.  Several of the professional managers I recommend have track records dating back 10 years or longer.  Of course, past results are no guarantee of future results.

Many of my subscribers have read about the active management strategies that I have suggested over the years, but have never checked them out.  Perhaps it’s because they represent a different way to invest, or perhaps it's because their brokers tell them such strategies don't work.

I urge you to make 2011 the year that you challenge Wall Street's conventional wisdom and get out of the buy-and-hold rut.  It costs nothing but your time to check out these active management strategies, but the payoff can be substantial, especially when (not if) we hit another bear market in stocks down the road.

To learn more about investment strategies designed to help you manage the risks of being in the market you can:

Let 2011 be the year that you stop being led by Wall Street's marketing apparatus and take charge of your own financial destiny. 

Wishing you profits in the New Year,



Chicago Fed Predicts Solid Economic Growth in 2011

National Debt Tops $14 Trillion

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Forecasts & Trends E-Letter is published by Halbert Wealth Management, Inc. Gary D. Halbert is the president and CEO of Halbert Wealth Management, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, Halbert Wealth Management, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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