Investment strategists, most economists and investor sentiment surveys see higher stock markets and economic growth in 2011. But there are voices of dissent, or at least caution.
In 1931, The New York Times celebrated its 80th anniversary by asking Henry Ford and other luminaries to forecast what the world would be like in 2011, another 80 years ahead. As the archives on the newspaper's website reveal, Mr. Ford envisioned more success "in passing around the real profit of life."
He may prove to be right. Investment strategists, most economists and investor sentiment surveys see higher stock markets and economic growth in 2011. But there are voices of dissent, or at least caution. Here are three reasons to be bullish for 2011 - and three reasons to be cautious.
Bullish: improving economic signals
Recent U.S. economic indicators hint that the self-sustaining phase of the business cycle may be close at hand. Retail sales have trended up since July to a three-year high, while jobless claims have declined, leaving the four-week average at its lowest point in nearly two and a half years.
The widely watched Weekly Leading Index published by the Economic Cycle Research Institute (ECRI) has risen to its best readings since May 28. Money supply and credit aggregates are turning up as well, observes institutional advisory BCA Research, suggesting banks are beginning to lend and firms to borrow.
Bearish: housing sector missing in action
Historically, the housing market leads U.S. economic recoveries. But stimulus so far has been "inadequate to lift home construction and sales," reports Asha Bangalore, senior economist at the Northern Trust Company in Chicago.
Adding to concerns, the S&P/Case-Shiller Home Price Index has started to go down in recent months and could fall further. "There is still roughly two years of unsold inventory overhanging the market once the 'shadow' foreclosure backlog is included," Gluskin Sheff chief economist David Rosenberg declares.
Bullish: supportive policy
Sparked by earlier fears of a double-dip recession, U.S. policy makers recently announced new measures to boost the economy. Bush-era tax cuts were maintained, the payroll tax temporarily cut by 2 per cent, and unemployment benefits extended.
The Federal Reserve announced a second round of quantitative easing, committing to the purchase of $600-billion (U.S.) in U.S. government bonds by June. The Fed wants to keep five- and 10-year Treasury yields down and encourage U.S. banks to lend rather than park funds in Treasuries, economists say.
Bearish: bond risk
If stimulus leads to growth quickening too much, the bond market could sell off, causing yields to shoot up and undermine the economy. The flash point is currently 3.8 per cent for 10-year U.S. Treasury yields, according to models developed by Peter Gibson, the CIBC World Markets chief portfolio strategist who has earned top rankings in the Brendan Wood International survey of analysts since 1994.
If yields breach this ceiling, the Fed will try to hammer them down with quantitative easing. If that doesn't work, the Fed could raise short-term rates to appease the bond market with the prospect of economic slowdown, Mr. Gibson says.
Bullish: healthy corporations
U.S. corporations are "in phenomenal shape" writes Tony Boeckh in the Dec. 17 issue of the Boeckh Investment Letter. Profit margins, at 8.7 per cent, are way above the long-term average. And cash balances are huge, led by the technology sector with a cash-to-equity ratio that exceeds 25 per cent.
If the recovery picked up, "those cash holdings could be used for M&A activity, capital investment, share buybacks and, of course, higher dividend payouts," Mr. Gibson writes. Exceptions may be exporters who keep cash balances offshore.
Bearish: state and local cutbacks
"One shock is the sharp pending drag from widespread and accelerating spending cutbacks and tax hikes at the fiscally strapped state and local government level [in the U.S]" Mr. Rosenberg points out. "This promises to be a major macro theme for 2011."
Funding pressures are going to be more intense when the "Build America Bond" program winds up. "The sector has laid off 250,000 people in the past year and more is to come as this crucial 13-per-cent chunk of the economy moves further into downside mode," he adds.