Where We Are and Where We're Headed in 2011
December 30, 2010
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It's that time again.
It's that time again.
.
Time to look at the last year, and to prognosticate for the future. We'll start my with my 2010 Predictions and score them.
The "can kicking" continues to be the issue, of course. Timing counts, and so when you make a prediction of both an event and a time, you have to be right twice, not once. Thus, on "random" you'd expect maybe 1/4 of the predictions to pan out, and on that basis I'm doing pretty well, I suppose.
But remember that many market callers were claiming we were going to 1350 last December. Now they're looking for 1450 -- just 125 points off the top of all time in October of 2007. Predicated on what, may I ask? The issue here is rapidly rising commodity prices, which are happening due to the rampant devaluation of the currency. That's all Bernanke, all the time, and is his "answer" to how we keep doing this:
That looks bad. This is worse:
There's been no "revelation" among those in government that this sort of deficit spending cannot be sustained.
Then again there wasn't in Greece or Ireland either ... right up until the system blew up in their faces and spreads went nuts. It will happen here, too; it's just a matter of time. GDP, while reported as positive by a couple of percent (2010 actual numbers won't be in until the finals for 4Q, well after this goes to press) are actually negative by about 7% when adjusted for deficit spending -- and they have to be, if one is going to be honest about it.
Then there's the Corporate Leverage Index -- that is, the amount of equity price (what you pay for stocks) that is not buying plant, property and equipment (tangible assets less outstanding debt) but rather pure speculative premium. Remember, equity is ownership -- the common metrics of stock values are all related to profits, but in point of fact you're an owner of the company when you own its stock, so at least part of your interest should be represented in physical "things" that have value. We're at record lows on that metric; in fact, we're so far beyond record lows as to belie any sort of rationalization.
That really is roughly double the level of the 2000 top, and three times that of the 2007 market top. While this does not necessarily mean that stocks must imminently decline (look at how long the index continued to rise from the historical 2.0 level in 1992 to roughly 7 in 2000, before it all came apart) but it does strongly suggest that there is a hell of a lot of risk in equity ownership -- in fact, more risk than ever before.
Everyone appears to be bullish coming into the new year. The mainstream media and the big banks are all telling you to "buy now." USA Today even ran this sort of story as a headline on its front page!
What does this mean? The stock market is profoundly unfavorable for investment at the present time. This does not mean that the market is unfavorable for speculation, as I discuss in my predictions. But if you're a long-term investor, trying to do what used to be called "saving" and are mostly a passive participant in the market, looking at it as a long-term means to accumulate capital, you have no business being in equities at the present time -- without exception.
Wizened old brokers used to talk about the "shoeshine" indicator: When your shoeshine boy started telling you what stocks he was buying and how much he was making, it was time to get short. Today there are no shoeshine boys of materiality, but there sure are boob-tube prognosticators, all of whom are trying to sell you something either directly or indirectly.
Next up is the ridiculous, which are found in state budgets. There, the red ink is serious and structural. Virtually every state in some form or fashion is in serious trouble, with the most-serious problems being found in states such as California and Illinois. In most cases these problems are found in the pension programs and other "forecasts" that put in effect actuarial results that are extremely unlikely to happen; in fact, it is virtually certain they will not. As such, these abuses must be resolved, but as with our government in general, they won't be -- right up until there's a crisis.
That crisis is emergent now in states like Illinois. Vendors are not being paid, in some cases for as much as six months or more. Some fuel stations will not accept state fuel cards for police cars, as they're simply not getting paid in anything approaching a reasonable amount of time. This sort of squeeze feeds back on the state severely, as those who have product will effectively embed a risk of default and interest premium into the price, and those who go under as a consequence of not being paid decrease competition. That can -- and will -- get out of control and ultimately destroy social services in particular, as most of them are provided by the states, not the federal government. Expect the incessant "It's for the children" arguments to intensify. It won't matter; the money doesn't exist, and attempting to tax it will only cause those who would pay those taxes to flee.
Then we have general mortgage issues. Absolutely nothing has been settled here, and it's a ticking financial nuclear device. I remain convinced, along with a number of others, that transfers into the trusts were simply not performed according to the PSA requirements for many (if not most) of these deals. The wheels of justice turn very slowly ... but they do turn, especially when the people on the other side of the table have money and lawyers -- and they do.
In fact, pension funds, insurance companies and other similar "investors" are some of the best-lawyered people in the land, and they make their money off of statistical analysis. There's more than enough there to blow all of the major financial institutions straight to Mars should my premise prove true ... and the more evidence that comes out, the more likely it appears that I'm right.
We're arguing over the length of the fuse, not whether or not it's lit.
We should have taken all the big banks into receivership in 2008 or 2009 and resolved them. We could have figured out where all these notes were, whether these "trusts" had anything in them, who (if anyone) did evil things and who has to eat the losses. Unfortunately, the answer thus far has been "all of us" through the back-door monetization and zero-interest-rate route, which has stolen billions from savers and retirees. More unfortunately, that route doesn't stop the bleeding, as the loss continues to compound until it is forced out into the open and written off.
Eventually this will be forced into the open and the losses recognized. Again, we're arguing over "when," not "what" or "if." Those who argue otherwise are, in my humble opinion, fools. Timing is always a problem with a thesis like this, especially when there are courts and lawyers involved, but this much is certain: Nobody is going to swallow a couple of trillion in losses if they have the ability to fight -- and they do have the ability. They'll fight, and when this risk becomes emergent, I hope the foolishness of our government's refusal to address the problem head-on in 2008 and 2009 will become apparent to everyone.
This in turn means that you've got a real pickle on your hands when it comes to long-term savings, otherwise known as capital accumulation. You can't be in stocks; you can't be in Treasuries (at today's prices, odds are that yields go up over the long term, which means price goes down); you certainly cannot be in corporate debt when the Corporate Leverage Index is at all-time highs. Municipal debt looks damned attractive on a yield basis, but you're playing Russian Roulette unless you are extremely careful, which means selecting individual issues ... and most retail investors of modest means cannot obtain sufficient diversification (due to the minimum "buy" size) to be comfortable on that path.
This, of course, is exactly what Bernanke thinks is "good" -- an attempt to entice you into equities by destroying the other reasonably safe options! First you get trashed by rampant greed and and fraud in 2000 and 2007, now Bernanke and the federal government are trying to do it again by destroying all other options for a reasonable return on saved capital ... and while they're at it, they're adding a dollop of "massive inflation fear" to the mix in an attempt to keep you from choosing to simply sit on cash.
Politically, we have a claim of "fiscal reason" coming to town in a few days with the new Congress. Reality is likely to be something very different from the claims. Among other things, there's the little matter of nearly $500 billion in new red ink (added to the existing structural deficits) for the next two years that were embedded into the system by Obama's latest games as Congress was coming to a close this month. We'll see if the Republican majority in the House (where all spending must originate, remember?) will have the stones to say, "No!" -- up to and including if that means shutting the government down. If not, we will get to find out how far the international community will let the Fed run with its QE games before they decide to pull the plug, either sending oil to $200/bbl (trashing the economy) or going on a buyer's strike in the bond market (forcing the raw nature of Bernanke's monetization out into the open).
Then there's China. Bernanke benefited from the entire world playing the "cheap money" game in 2008, 2009 and 2010. This has now ended; China is raising rates and Australia has been doing so for some time. Canada is on the verge of its housing bubble exploding in its face, and Australia is in trouble in this regard as well.
China, for its part, has had it with our exporting inflation and the sale of worthless financial instruments.
Some of this was undoubtedly "rectified" behind closed doors in 2008 (remember, we actually had Congressmen on the floor who said we were bailing out China from their bad investments back then), but the fact remains that we've done nothing to resolve the trade imbalance and labor exporting that led to the alleged "Chinese Miracle" (which, in point of fact, is really slavery, jackbooted government games and environment arbitrage).
The politburo appears to have figured out that this game has a fast-approaching expiration date, and is attempting to move its targets. That will fail simply because the structural imbalances embedded into the system will take too long to fix -- and there is plenty of corruption (not to mention just plain old-fashioned fraud in their supposed economic "reporting") over there, too.
Finally, we have the North Koreans. Torpedoing a military ship appears to have been tolerated. Whether it'll get away with shelling an island is another matter. So far it hasn't led to open warfare, but I wouldn't hold my breath on that point. And remember, while the Norks do not have much in the way of delivery systems, they do have at least a handful of crude nuclear bombs. Whether they'll use them (or attempt to use them) is an unknown.
With all of this in mind, let's get right down to it: The 2011 Predictions.
Time to look at the last year, and to prognosticate for the future. We'll start my with my 2010 Predictions and score them.
- This is not a new bull market; the market will be lower on December 31. Miss, but I think I get half-credit. Why? Because 1220 is about where we are now, and that's what I said we'd get somewhere during the year. Considering that virtually everyone was looking for 1350 and that wasn't achieved, I can't say it was a terrible call. Nonetheless, up is up, and I called down, so despite being nearly bang-on for an intermediate top at 1220, we're up from January 1. Half-point.
- The long end of the curve will move higher. I didn't define what "long end" was, but most people consider the 10-year to be the "long end." It's lower than it was on January 1. Miss, even though it's trending up now. Timing is part of the prediction, though, so trend or no trend, it's wrong. Zero.
- House prices will fall another 20%. Not yet. Miss. However, prices are lower (from the last quarter's report, which was issued on November 30) from the year-ago levels, so there has been no recovery. Nonetheless, again time is a factor, so I get zero points on this one.
- Banks will "give up" on holding real estate and will dump foreclosure inventories. Big hit. Foreclosure sales in fact got so frantic that banks were foreclosing without having the legal documents to do so, turning to "robosigning" and other alleged offenses. I should be able to get two points when a prediction hits so solidly that the people who were predicted to do something resorted to what can be argued as rampant criminality to accomplish it, but I never set that as a condition. Nonetheless, that's a big hit.
- Credit will not ease for "ordinary people." Hit. No decrease of materiality in credit card rates, credit outstanding is decreasing, and except for student loans, all credit for consumers is down huge and continuing. In fact, revolving credit has been declining at a 10% annualized rate all year long.
- A massive second wave of small-business bankruptcies will sweep the nation. Not yet. Miss. Although if anything I'm seeing thus far is to be believed, it's happening -- just not "massive" and "as reported." In certain areas (i.e. the "Inland Empire" of California) the rate is up by almost 10% annualized -- but there are pockets of improvement too. No points.
- Unemployment will appear to be stabilizing but that will prove illusory. We finish 2010 over 10%. Damn close. It is definitely not improving. I'll take a half-point, and may have to revise it since December's report isn't in yet; I might get the other half in a few days.
- The "revolting" call was early, but not wrong. Nope. Miss. Although there have been riots, no coups. Yet.
- The states will go to the government well for handouts, and probably will get them, but it won't matter. Hit. Governor Chris Christie (N.J.) is the only one dealing with this honestly. Employment of government leeches, er, "staff" continues to decline and deficits and hiding of the truth continue. California and Illinois are the worst two, but not the only ones in trouble. This is a story for 2011 and there's a prediction related to it below as to how this plays out. The market has figured it out too; look at things like IQI, the levered muni fund, NUV, or several others. They're trading below 1/2010 levels.
- A "double dip" will be recognized by the end of the year. Miss. But wrong likely on timing, not facts. The ISM Manufacturing spread between inventories and new orders is at impending recession levels. Looks like they kicked the can a bit better than I expected, but now it's full of cement. We'll see.
- China will lose control of its property and plant bubble. Miss. Coming as well, but not yet. Timing is everything.
- Canadian real estate will show signs of cracking. Yep. It hasn't blown up yet, but I didn't say "blow up," I said "signs of cracking," and it's there. There are even warnings coming from there at this stage. Point.
- The Fed's games will "leak" and credibility will be shaken. Point. Leaks forced the release of its lending data, Ron Paul's ascendancy, and more. This has all the ingredients for fun in 2011 -- let's see if we get it.
- The Dems lose big in the House. Big point. That was a rout and nobody can argue it.
- Congress continues to try to spend its way out of the recession and runs into rising rates. It did and Bennie is causing the rising rates. Amazing, really. Half-point for what Congress tried and I took the full-point miss up above on the rate prediction.
- One or more of the PIIGS either defaults or is forced into austerity. Hit. Pick one. Greece and Ireland were forced literally, and the others are trying to preempt. That ain't over.
- Return of capital will reassert itself. Nope. Miss.
The "can kicking" continues to be the issue, of course. Timing counts, and so when you make a prediction of both an event and a time, you have to be right twice, not once. Thus, on "random" you'd expect maybe 1/4 of the predictions to pan out, and on that basis I'm doing pretty well, I suppose.
But remember that many market callers were claiming we were going to 1350 last December. Now they're looking for 1450 -- just 125 points off the top of all time in October of 2007. Predicated on what, may I ask? The issue here is rapidly rising commodity prices, which are happening due to the rampant devaluation of the currency. That's all Bernanke, all the time, and is his "answer" to how we keep doing this:
That looks bad. This is worse:
There's been no "revelation" among those in government that this sort of deficit spending cannot be sustained.
Then again there wasn't in Greece or Ireland either ... right up until the system blew up in their faces and spreads went nuts. It will happen here, too; it's just a matter of time. GDP, while reported as positive by a couple of percent (2010 actual numbers won't be in until the finals for 4Q, well after this goes to press) are actually negative by about 7% when adjusted for deficit spending -- and they have to be, if one is going to be honest about it.
Then there's the Corporate Leverage Index -- that is, the amount of equity price (what you pay for stocks) that is not buying plant, property and equipment (tangible assets less outstanding debt) but rather pure speculative premium. Remember, equity is ownership -- the common metrics of stock values are all related to profits, but in point of fact you're an owner of the company when you own its stock, so at least part of your interest should be represented in physical "things" that have value. We're at record lows on that metric; in fact, we're so far beyond record lows as to belie any sort of rationalization.
That really is roughly double the level of the 2000 top, and three times that of the 2007 market top. While this does not necessarily mean that stocks must imminently decline (look at how long the index continued to rise from the historical 2.0 level in 1992 to roughly 7 in 2000, before it all came apart) but it does strongly suggest that there is a hell of a lot of risk in equity ownership -- in fact, more risk than ever before.
Everyone appears to be bullish coming into the new year. The mainstream media and the big banks are all telling you to "buy now." USA Today even ran this sort of story as a headline on its front page!
What does this mean? The stock market is profoundly unfavorable for investment at the present time. This does not mean that the market is unfavorable for speculation, as I discuss in my predictions. But if you're a long-term investor, trying to do what used to be called "saving" and are mostly a passive participant in the market, looking at it as a long-term means to accumulate capital, you have no business being in equities at the present time -- without exception.
Wizened old brokers used to talk about the "shoeshine" indicator: When your shoeshine boy started telling you what stocks he was buying and how much he was making, it was time to get short. Today there are no shoeshine boys of materiality, but there sure are boob-tube prognosticators, all of whom are trying to sell you something either directly or indirectly.
Next up is the ridiculous, which are found in state budgets. There, the red ink is serious and structural. Virtually every state in some form or fashion is in serious trouble, with the most-serious problems being found in states such as California and Illinois. In most cases these problems are found in the pension programs and other "forecasts" that put in effect actuarial results that are extremely unlikely to happen; in fact, it is virtually certain they will not. As such, these abuses must be resolved, but as with our government in general, they won't be -- right up until there's a crisis.
That crisis is emergent now in states like Illinois. Vendors are not being paid, in some cases for as much as six months or more. Some fuel stations will not accept state fuel cards for police cars, as they're simply not getting paid in anything approaching a reasonable amount of time. This sort of squeeze feeds back on the state severely, as those who have product will effectively embed a risk of default and interest premium into the price, and those who go under as a consequence of not being paid decrease competition. That can -- and will -- get out of control and ultimately destroy social services in particular, as most of them are provided by the states, not the federal government. Expect the incessant "It's for the children" arguments to intensify. It won't matter; the money doesn't exist, and attempting to tax it will only cause those who would pay those taxes to flee.
Then we have general mortgage issues. Absolutely nothing has been settled here, and it's a ticking financial nuclear device. I remain convinced, along with a number of others, that transfers into the trusts were simply not performed according to the PSA requirements for many (if not most) of these deals. The wheels of justice turn very slowly ... but they do turn, especially when the people on the other side of the table have money and lawyers -- and they do.
In fact, pension funds, insurance companies and other similar "investors" are some of the best-lawyered people in the land, and they make their money off of statistical analysis. There's more than enough there to blow all of the major financial institutions straight to Mars should my premise prove true ... and the more evidence that comes out, the more likely it appears that I'm right.
We're arguing over the length of the fuse, not whether or not it's lit.
We should have taken all the big banks into receivership in 2008 or 2009 and resolved them. We could have figured out where all these notes were, whether these "trusts" had anything in them, who (if anyone) did evil things and who has to eat the losses. Unfortunately, the answer thus far has been "all of us" through the back-door monetization and zero-interest-rate route, which has stolen billions from savers and retirees. More unfortunately, that route doesn't stop the bleeding, as the loss continues to compound until it is forced out into the open and written off.
Eventually this will be forced into the open and the losses recognized. Again, we're arguing over "when," not "what" or "if." Those who argue otherwise are, in my humble opinion, fools. Timing is always a problem with a thesis like this, especially when there are courts and lawyers involved, but this much is certain: Nobody is going to swallow a couple of trillion in losses if they have the ability to fight -- and they do have the ability. They'll fight, and when this risk becomes emergent, I hope the foolishness of our government's refusal to address the problem head-on in 2008 and 2009 will become apparent to everyone.
This in turn means that you've got a real pickle on your hands when it comes to long-term savings, otherwise known as capital accumulation. You can't be in stocks; you can't be in Treasuries (at today's prices, odds are that yields go up over the long term, which means price goes down); you certainly cannot be in corporate debt when the Corporate Leverage Index is at all-time highs. Municipal debt looks damned attractive on a yield basis, but you're playing Russian Roulette unless you are extremely careful, which means selecting individual issues ... and most retail investors of modest means cannot obtain sufficient diversification (due to the minimum "buy" size) to be comfortable on that path.
This, of course, is exactly what Bernanke thinks is "good" -- an attempt to entice you into equities by destroying the other reasonably safe options! First you get trashed by rampant greed and and fraud in 2000 and 2007, now Bernanke and the federal government are trying to do it again by destroying all other options for a reasonable return on saved capital ... and while they're at it, they're adding a dollop of "massive inflation fear" to the mix in an attempt to keep you from choosing to simply sit on cash.
Politically, we have a claim of "fiscal reason" coming to town in a few days with the new Congress. Reality is likely to be something very different from the claims. Among other things, there's the little matter of nearly $500 billion in new red ink (added to the existing structural deficits) for the next two years that were embedded into the system by Obama's latest games as Congress was coming to a close this month. We'll see if the Republican majority in the House (where all spending must originate, remember?) will have the stones to say, "No!" -- up to and including if that means shutting the government down. If not, we will get to find out how far the international community will let the Fed run with its QE games before they decide to pull the plug, either sending oil to $200/bbl (trashing the economy) or going on a buyer's strike in the bond market (forcing the raw nature of Bernanke's monetization out into the open).
Then there's China. Bernanke benefited from the entire world playing the "cheap money" game in 2008, 2009 and 2010. This has now ended; China is raising rates and Australia has been doing so for some time. Canada is on the verge of its housing bubble exploding in its face, and Australia is in trouble in this regard as well.
China, for its part, has had it with our exporting inflation and the sale of worthless financial instruments.
Some of this was undoubtedly "rectified" behind closed doors in 2008 (remember, we actually had Congressmen on the floor who said we were bailing out China from their bad investments back then), but the fact remains that we've done nothing to resolve the trade imbalance and labor exporting that led to the alleged "Chinese Miracle" (which, in point of fact, is really slavery, jackbooted government games and environment arbitrage).
The politburo appears to have figured out that this game has a fast-approaching expiration date, and is attempting to move its targets. That will fail simply because the structural imbalances embedded into the system will take too long to fix -- and there is plenty of corruption (not to mention just plain old-fashioned fraud in their supposed economic "reporting") over there, too.
Finally, we have the North Koreans. Torpedoing a military ship appears to have been tolerated. Whether it'll get away with shelling an island is another matter. So far it hasn't led to open warfare, but I wouldn't hold my breath on that point. And remember, while the Norks do not have much in the way of delivery systems, they do have at least a handful of crude nuclear bombs. Whether they'll use them (or attempt to use them) is an unknown.
With all of this in mind, let's get right down to it: The 2011 Predictions.
- We're not going to get away with spending another $450 billion in deficits on top of the $1.6 trillion we blew last year. $2 trillion in deficits? Not a prayer. Sen. Tom Coburn (who voted for TARP, incidentally) said we had "four or five years" to get this under control. Nope. The time is now, and this will be the year where the strain shows up in very uncomfortable ways. Since we put in place hundreds of billions in tax incentives and changes for the next two years, and the Republicans won't back off on that, we're going to see some sort of spending issue.This should get interesting, given the Senate and Obama in the White House. What the Democrats seem to forget is that not spending is in fact something the Republicans can do, whether the Democrats like it or not, as they can refuse to pass and send up appropriations bills or continuing resolutions. The only question remaining on the table is whether the Republicans will come to town and do this, or whether the market will force them to do it. Pick one; either way, "entitlement nation" is about to get a surprise. Incidentally, I see this as emergent in 2011 but really getting ugly into the elections in 2012 -- which sets up a number of interesting scenarios for that year.
- Europe will not get its debt situation under control. I give us a 50/50 chance that Ireland repudiates it's "deal" immediately following its elections, and the cancer there will spread. I won't call a breakup of the euro -- yet -- but the possibility exists that one or more nations will leave the common currency next year. I only see the odds as something around 50% though, so it doesn't go on the "prediction" board for this year.
- The dollar remains the hooker with crabs, while many other currencies have AIDS. The wildcard is the British pound. Britain may actually have its act under reasonable control; we'll see. For the euro, no such luck. I expect a wide trading range with lots of both euphoria and tears, perhaps as much as 40% or more. That means we'll get plenty of whipsaws in the IDX as well. Nonetheless, the doomers' call of a dollar collapse and gold at $3,000+/oz will be wrong.
- Oil is going to $100, and maybe considerably higher; not on demand, but rather on a "safe haven" and speculative play. Go look at 07/08 for how this plays out. And get ready for the bad effect on your wallet from higher gas prices. I expect the $4 line to be breached in high-cost areas by the summer, and we may see $5 gas this year. But by the end of the year, oil will be on the decline, again. And again, it will be because the economy is in fact going down the tubes.
- Commodities will continue to ramp right up until oil tops, as the economic reality that "charge it" can't fix what's broken sinks in. Recognition will come hard and fast, and metals will not be exempt. When oil starts to roll over, beware. Everyone loves commodities. When everyone's on the same side of the boat, it usually tips over ... and there are sharks in the water below.
- Fannie (FNMA.OB) and Freddie (FMCC.OB) will get some sort of "resolution" path -- and it won't be positive for them. There's wide agreement that they were part of the problem. The Republicans will blame the CRA, as has been their refrain for years, but in the end it won't really matter. Expect an intermediate-term solution that prices Fannie and Freddie out of the mortgage market over the next five to 10 years ... but my best guess is that the government doesn't have the stones to force the bad paper back where it belongs; not entirely, anyway. The government will also not be willing (or able) to keep its paws off the market, and this may well lead to a new crisis in another five years or so. In other words, they'll "fix" it by breaking it worse. The best bet is that Fannie and Freddie get "merged," and they'll try to hide the bad paper. That may work for the Fannie and Freddie mortgage-backed securities (MBS), but ...
- "Someone" will pry open the REMICs in MBS-land for at least private-label deals, and fun will ensue. Don't be long big banks when it happens. The wheels of justice turn slowly, but they do turn, and I believe 2011 will be the year when the logjam breaks. This, incidentally, is the one prediction that in my opinion is the highest-risk; the banks know this bomb is ticking and will try to defuse it through some sort of backdoor deal. I don't think they'll get it done; the lawyers smell blood and there's too much money to be made taking bites out of some very fat cats. If I'm right, there will be at least one burnt offering made -- probably Bank of America (BAC) -- and, if it comes at the wrong time, it won't stop there. If this gets going in the middle of a broad market sell-off, Lehman will look like a cakewalk.
- China will roll over as its attempts to tighten policy have come too small and too late. China too has too many plates in the air. Anyone who thinks that you can build cities full of apartments with nobody living in them and not have it blow up in your face is ridiculously naive. Is China a good bet down the road? Sure, once that speculation comes out and the pricing adjusts. But this isn't in the here and now.
- Housing is and will "double-dip." There's no bottom. Those who bought the gamed reflex bounce on the tax credits and faux "stabilization" are in big trouble. My projection is for a mid-single-digit to 1x% decline in prices nationally in 2011 ... and even then it won't be over.
- States will try to tax their way out of pension trouble, and fail. The Whitney call will be wrong, but only because of how she phrased it. States and municipal governments will be increasingly recognized as insolvent but they will continue to play games to try to stretch cash flow rather than defaulting outright. The States will not get bailed out (again) by the Feds; the money isn't there. Beware the municipal bond market -- IQI, for example, looks damned enticing right now in the $11s, down from $14 and yielding 7.3% tax free. That sort of spread over Treasuries is beyond insane, especially with the tax preference, and is pricing municipal debt as trash. If you like gambling and want to bet that the states will pull it off, it's hard to beat a current 7%+ tax-free coupon and a potential 20% or more price appreciation potential on top of it. The problem with such appearances of a free lunch is that the sandwich offered to you is almost always laced with arsenic.
- Between forced state austerity and semi-forced federal austerity, the rug will get pulled out from the master "credit card spending" support chart above. The disruption that will become evident, especially in the back half of the year, will be material. But the worst of it won't be in 2011; it will be in 2012 and beyond.
- Fed Index price paid/received divergences, along with inventory build, say we're going to double-dip in the general economy. I believe it. The Fed has of course tried to stop this with its QE games, but it's not getting the effect it claimed it was after. The Hopium runs out in 2011, and the addict will go through withdrawal.
- Margin compression will become realized. I'm just about the only one who's been talking about it in the back half of 2010, based on the PPI/CPI reports and regional Fed indices, but that won't last. We'll start to see it in the Q4 earnings, and by Q1 people will be talking about it. This will put a cork into the "multiple expansion" nonsense that a whole lot of "pundits" have been running over the last year.
- The inventory build we've experienced will prove to have been unwise. Expect a cycle of write-downs which will further damage earnings. Unsold inventory is a millstone around your neck. I've been talking about the warnings evident in the data on this for six months or so. The bet the market has made is that this will be sold through. Nope.
- The Fed will get neutered, but it won't be due to Ron Paul. He'll huff and he'll puff and then blow a raspberry instead of blowing down its house. It won't matter. Bernanke's credibility will be severely trashed by the end of the second quarter, as his monetization will be increasingly seen by Republicans as nothing more than a way to pander to the profligacy of Congress (which they'll try to pin on the Democrats, despite their own fully complicit role in it). The end result (albeit through the typical partisan baloney) will be that QE2 is the last time that happens, period. I expect an all-on attempt to change the Fed mandate to remove "employment" and possibly define "stable prices." These two things, incidentally, would be tremendously positive, and the first might actually succeed. The second? Don't hold your breath. Dennis Kucinich's bill would be even better, and it will be reintroduced -- and fail to gain any material sponsorship, including from the Pauls. Somewhere around the middle of the year this entire dynamic starts to become interesting, in the 2012 Presidential sense.
- The TNX will hit 4%, likely in the first quarter. The bad news is that spreads are likely to widen against everything else. Paradoxically, if we do get forced austerity -- even a hint of it -- on the federal spending side (and I believe we will), we'll see rates on the long end remain in won't control post-QE2. They collapse as they did post-QE1, but they also won't go bananas on the upside. Scratch that latter half prediction if the GOP rolls over on spending or, worse, tries to ram through more tax cuts (and it might); if so, you'd better buckle up, and the trade of the year will be to short the long end of the curve.
- We won't get bond auction "fails," per se (that's impossible, given the Primary Dealer setup), but there will be plenty of "D"s and "F"s in terms of grades, with lots of tail showing. Again, I expect this mostly in the first half of the year -- unless the Republicans do something stupid (see the above item). This of course won't do good things for mortgage rates and stability in the mortgage market (which feeds into the housing projection above).
- The market will roll over this year. And not in a small way either. We may finish the year over 1,000 on the SPX, but we're going helium-style diving at some point first. Since timing is everything in this game, I'll stick my neck out: There will be a sucker sell-down early this year, the market will bounce, and then hell will reign on Earth later in the year and into 2012. If you want an analogue for it, look at 2000 -- and before you buy into the end of the year, note that buying the 2000 Christmas rally into January 2001 was one of the worst mistakes you could have ever made. Momos will crack first; this has probably already started. If even half of the above predictions play out, the odds of an outright crash are quite high, as the market has priced in an actual recovery. I don't see it; what I see is unemployment remaining high, and we're trying to hide it with the government credit card. There are too many plates in the air on too many sticks -- and someone's gonna drop one.
- Expect extreme volatility. Anyone thinking the VIX in the teens makes sense is going to be proven to be nuts. There will be insane money-making opportunities for short-term speculative traders in both directions, bull and bear, in 2011. If you're short volatility in 2011, you're going to get trashed. The Corporate Leverage Index will become realized risk in 2011. I expect more than one extreme "crash-like" move during the year; the bad news is that not all of them will retrace. "Buy the dips" has been good for 18 months. Do it at the wrong time in 2011 and you're dead, especially if you're levered ... and from the margin stats at present, a lot of people are. Hint: Take that risk down now!
- The potential for a regional war to break out is extremely high. I won't score this one, because I only give it a 50/50 chance. But 50/50 is so far beyond the usual boundary of risk for these events that it deserves mention. The most likely and obvious place it happens? North Korea -- but that's not the only flashpoint. I'm very concerned about a number of other areas across the globe, including some that are off most people's radar at the moment.
- Civil unrest will spread beyond a few demonstrators in Europe. This includes the possibility of unrest in the United States. The federal government knows that as long as the food stamps and other general handouts continue they can keep a lid on things, but the fraying around the edges is apparent even now. It only takes one bad court decision or one person who is the wrong color and gets beaten in the wrong place by an overly-militarized police department to set off generalized unrest. The federal government's utter refusal to deal with the outrageous actions in Foreclosure-gate, along with bad acts by various parties, private and public (e.g. police departments), are stoking the firebox with dry tinder and spraying gasoline all over the place. All we need is a match to get lit and things will get out of control very quickly. While the federal government should preempt state and local laws and make unfettered ownership of defensive arms available to all everywhere, the clowns in D.C. are too stupid to understand that when defensive force is needed in seconds to stop an arson, assault, or murder, 911 will be there in 10 minutes -- if the local cop shop's cars aren't out of gas. In 2007 I called upon Congress to set aside a hundred billion or two for "three hots and a cot" -- literally -- for up to 25% of the population for a year or more. I wasn't kidding, but now it's too late as we don't have the money, and there's zero evidence that, at least in the big cities and other "liberal bastions," law enforcement understands that it cannot win against armed thugs; there are and will be too many of them. The only way peace can be maintained in such a circumstance is if the people are willing and able to help the police ... and that means unfettered ownership and carrying of defensive arms. The radical left is beyond ridiculously wrong on this one, and we can only hope that this prediction turns out to be in error, especially if you live in a city of more than 500,000. The wise will figure out right now what they're going to do (and "shelter in place" is not one of the valid choices) if this prediction turns out to be correct.
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