Opinions Investor's Corner Investor’s Corner - John Gudritz: The markets in 2011 - It’s a matter of confidence
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Investor’s CornerBy John Gudritz CFA
Principal
Front Street Investment Management LLC
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Throughout this economic recovery, which officially started in the summer of 2009, there has been a debate among economists concerning its growth potential over the next five years. Despite the acceleration in the economy over the past few months, I have been in the “new normal” camp that believes that the U.S. economy’s growth will tend to be in a 1.5-2.5 percent range for the next few years as we as a people and a country get back to living within our means. However, there are economists who are much more bullish and expect economic growth to accelerate in 2011 to 3-4 percent per year or more. I hope they are right.
Investors have also been debating about whether or not the stock market is in a new secular bull market or just a shorter term cyclical bull market within a longer term secular bear market. The stock market seems to be assuming the better scenario as it currently hovers near the levels last seen in August 2008. I still believe that the market is in a secular bear market and that it’s vulnerable to test the lower end of the trading range if the economy slows to a more sustainable 2-2.5 percent rate as 2011 progresses.
The good news for the economy in 2011 is that the government came together to extend the tax cuts for the next two years. Had that not happened it’s likely that the economy would’ve slipped back into a recession. The bad news is this extension only adds to the deficit and delays any real effort to come up with credible solutions to that long-term problem.
What I have found most disconcerting about the economic and stock market recoveries are the lack of confidence in both of them. Corporate management continues to express concern about the sustainability of the strength of this recovery and investors continue to put most of their money into bonds. They have only recently begun to come back into the stock market.
Consumer confidence has improved in recent months but is still at levels normally associated with recessions. That is easy to understand with the unemployment rate still near 10 percent and the underemployed rate at 17 percent. It also doesn’t help that we hear that real estate prices are still declining in most areas of the country. Americans are still down over $1 trillion in wealth from the peak in 2007 despite the run up in the stock market.
The housing market will suffer until the state governments and the banks decide how they are going to rectify the past procedural problems in the foreclosure process. This only slows down the real estate market’s ability to get prices down to the level that enough buyers come back into the market to support prices going forward. Obviously, if the banks are made to suffer by having to take these bad loans back onto their balance sheets then the long awaited real estate recovery is still in the distant future.
Consumers won’t feel confident until they see a lot of improvement in their job prospects. Even people with jobs need to feel more secure in their present position or have confidence that they can easily find another job. While I expect to see the monthly employment numbers continue to improve in 2011, I don’t expect to see the unemployment rate get below 9 percent next year. In addition, I believe that companies will continue to be stingy with their pay raises in this “low inflationary” environment.
While the “core” rate on inflation, excluding food and energy, should remain below 2 percent in 2011, there is risk that food and energy prices will continue to rise at a faster pace. We no longer have the excess supplies of oil and agricultural products that we have in past years. Some of that is due to supply interruptions from bad weather but a lot of it is due to an increase in demand from emerging countries in Asia. China has recently started increasing their interest rates because of rising inflationary pressures in their country.
As an indication of corporate America’s lack of confidence in the economy, there has been a large increase in the amount of “insider selling” within publically traded companies. According to a provider of such data, TrimTabs Investment Research, the top corporate managers are “bailing out of their employers’ shares at the fastest rate since the stock market topped out in late 2007.” In November alone it amounted to about $11 billion worth of stock.
If I am right about the “new normal” economy with the relatively low sustainable growth rate and continued high unemployment, then I don’t expect confidence levels to return to what we saw in 2007 any time soon. I believe that will keep the stock market and the bond market in their respective trading ranges with maybe even more volatility than we saw in 2010. The market is now telling me that I am wrong as it did in October 2007. We shall see.