Beating Wall Street: A Scorecard Of Our “20 Investment Themes For 2011"

bullseye target dart board

As we rapidly approach the midpoint of what has turned out to be a very event-packed and volatile year, it’s time to review where we have been, where we are and where we are headed relative to the 2011 forecast we presented to BI readers back on January 3.

To briefly summarize our progress year to date relative to those predictions…So far so good.. Despite all of the economic speed bumps,  market volatility and black swan events….we are on track.

For clarity and transparency purposes, let’s review, critique and update each of them:

  1. The US Economy Continues to Struggle! Strong growth proves elusive. Policy makers maintain their “kick the can down the road” strategy which they can only hope buys more time to allow the struggling economy to heal and gain traction. As the Federal Reserve printing press continues to work overtime, policy makers continue their dangerous postponement of much needed entitlement reform and ignore nasty global trade imbalances. A tepid cyclical GDP rebound of 2.5% occurs by default…with a weaker first half followed by a stronger second…a reverse of 2010. Lousy growth comes with a multi trillion dollar price tag and continued erosion of the US $’s coveted reserve currency status.  Readers will recall at the beginning of the year that a majority of Wall Street’s highly paid economists were very bullish on the economy…many had overly optimistic GDP forecasts of upwards of 4% for the year….WALL STREET WAS WRONG and in recent weeks, all, including Goldman, BAC, JPM etc., have been rapidly downgrading their economic outlook closer to our more realistic forecast of 2.5%. I hasten to point out that the Fed, as evidenced by their move yesterday to lower their economic forecast, was also overly optimistic.  As DC policy makers continue with their failure to get an optimal pro growth monetary and fiscal policy mix combined with serious entitlement reform,  we may be compelled to lower our growth outlook more at our next quarter end strategy session.
  2. Stocks Disappoint the Bulls. Risk investors suffering from chronic “cyber brain sclerosis” continue to be led around by the nose by the long term is lunch High Frequency Traders. Investors continue to drink the spiked reflation policy Kool-Aid and worship at the “Bernanke Put” altar. After another volatile year characterised as the “Agony and Ecstasy” market where stocks swing 10% either side of the flat line…the S&P 500 closes up a miserly 8% on the year. Cutting through our hyperbole, the equity market action so far this year has played out as predicted….trading 10% (give or take a couple of %) on either side of the flat line… YTD the S&P 500 is basically flat .Again, like our economic forecast, this was a contrarian view as most of Wall Street was overly bullish which was best evidenced by the 2011 Barron’s Roundtable where predictions from the esteemed panelists were for positive equity returns of anywhere from 10 to 20% this year….so far WALL STREET IS WRONG…we anticipated a correction in the first half (see #20) and we are in the midst of it now.
  3. The Bond Bears Are Disappointed!..Again! And why not? Core inflation continues to hover near the flat line and will not rear its ugly head again for sometime as the world’s consumer of last resort (that would be the United States) continues to delever. The predominant “Triple D” theme of delevering/disinflation/deflation continues to keep interest rates locked in the range where they have resided for the past 10 years. With China et al continuing to export wage deflation pressures and maintaining huge surplus’s …look for a return of the “Bond Conundrum” theme in 2011. The bell weather 10 year Treasury has a trading range between 2.75 to 4.75% and with a bit better growth in the second half ends the year closer to high side of the range. We are rapidly approaching our low end of the range yield target on the 10 year Treasury of 2.75% (currently trading at 2.90%). To the disappointment of many of the well known bond bears like Pimco’s Bill Gross, there is a strong probability that we will overshoot this level. Originally Mr. Gross and his fellow bears  feared that the end of QE 2, with no QE3 to follow, would lead to significantly higher interest rates. THEY WERE WRONG! Treasuries continue to rally and now Mr. Gross, as evidenced by his Tweet yesterday,  is falling in line with our thinking that we can expect an extension of yet to be named QE 3 sometime later this year. We believe that there is a strong chance, in a “Hail Mary”  Fed effort to revive the double dipping housing market, and that they will target the 10 year plus maturities in the Treasury complex which could drive Treasury yields (and mortgage rates) to historic lows.
  4. The Superficiality of the “IPad Economy” is Unmasked! After a strong holiday retail season the thin growth veneer of the gadget buying consumer fades, revealing and re-emphasising the real structural challenges that the economy faces…ie a persistent high unemployment rate of 9.5 to 10% and a double dipping real estate market. Unlike us, most Wall Street economists, The Fed and the Administration predicted that the trillions of fiscal and monetary stimulus thrown at the economy since the beginning of the financial crisis would help the economy gain traction in 2011…especially it would help improve the terrible unemployment situation and the lousy housing market.  THEY WERE WRONG! Unemployment remains stubbornly high and getting worse…and as forecast the housing market is double dipping. In fact, as we concluded in January, most of these misguided policies only made things worse!!
  5. The Country Enters the Third Year of the Third Term of the Bush Administration! This is actually good news as President Obama continues his freshly minted pro business pivot! Hey…we are in the third year of the Presidential election cycle and it’s time to think about re-election. So…it’s pivot time! Look for all kinds of pre-election goodies and handouts to the one sector of the economy that historically gives copious campaign donations…especially to beleaguered presidential incumbents who have suffered from bad policy syndrome. That sector would be the financials. Ignore the nasty rhetoric against the GOP…that’s merely deflection and geared to placating POTUS’s abandoned liberal base…and go buy the banks and brokers as they will be one of the best performing sectors of 2011. A work in progress…yes POTUS has pivoted on some issues like extending the Bush tax cuts…but on the spending side the jury is still out. But I must admit…surprisingly, so far overall, the President has remained a liberal ideologue on the economy rather then a Clinton inspired political and economic pragmatist, this will most definitely change as we approach the election…in fact from a foreign policy standpoint..the pivot has already begun and is proceeding.
  6. The current US ambassador to China, Jon Huntsman, The former two term GOP governor of Utah, resigns his post to seek the GOP’s nomination for President. The Mandarin speaking Ambassador and successful governor becomes the GOP front runner. Good news for the G2 economy. Very few political commentators were talking about this guy back in January…and most who were…dismissed him…some still do. But here he is this week declaring his candidacy in a mixed field of what we believe are unelectable candidates…. he will become the GOP front runner and, if the economy, as we expect, remains in irons for the next year,  stands a good chance of becoming the next President of the US!
  7. The Tea Parties Bark Proves Worse Then Its’ Bite…..After initial electoral success and big reform promises followed by the big individual disappointments from the pace setting RINO like MA Senator Scott Brown..political and economic reality sets in at their caucus meetings. Tea Partiers, while keeping the austerity rhetoric volume turned up, recognise (absent the political guts to implement real reform and lacking Senate and WH support) that the only thing separating the economy from the abyss is the Bernanke Put! And as a result Ron Paul’s Fed oversight hearings are terrific political theatre and great for CNBC’s ratings…but not much else. I don’t know about you fellow BI’rs, but I am extremely disappointed by performance of the Tea Partiers…so far. It appears they rode into town spouting alot of great fiscal austerity rhetoric and apparently continued to ride right on thru! Where are their stars?…Ron Paul was going to take on the Fed…as predicted…he punted as economic reality set in and he realised The Bernank, in the context of the faltering economy, was the last policy maker left standing. Rand Paul? MIA… Marco Rubio? MIA….Scott Brown…AWOL….It’s been left to the old guard GOP to do all the heavy lifting….thanks Congressmen Ryan and Cantor. I have been told to be patient and wait til next year’s general election…but the country and the economy can’t wait…our problems are now…and the debt clock is ticking.
  8. The GOP Led Push to Repeal Obamacare Falls Flat! The new GOP Congressional leadership will talk alot about withholding funding in the coming year but most of the law’s impact in 2011 will be via new rules requiring zero funding. The real political battle over healthcare comes in 2012. Regardless…the enormity of this new and extremely expensive entitlement program will begin to weigh on investors minds and negatively impact sentiment beginning in 2011. Avoid the drug stocks. The GOP has pretty much given up…for this year…on any repeal of Obamacare. Indeed it appears to be in a self destruct mode as we learn from former Speaker of the House Pelosi’s comment that….we will learn more about the bill after it is passed…then we can read it. What everyone is reading they don’t like as public support for this whale sized legislation is sinking…fast.  We may have a truce for now…but the battle continues next year.
  9. Absent Global Leadership to Fix Distorted Trade Imbalances, by default the US $ Retains Reserve Currency Status. The dollar rallies early in the year and ends it modestly higher. The $ rally is beginning a little late…but it is beginning now.
  10. Protectionism and Competitive Currency Devaluations Continue to Simmer!…But only in the background and they become less of a concern as the year comes to a close.  There have been some notable currency devaluations this year…but they have been at the margin…The Belarus Ruble down 56%…and the Vietnamese Dong…but the grand daddy of devaluations continues to be China’s Yuan…followed closely of course by our own ongoing devaluation of the $ which goes to the failure to address global imbalances between the G2 countries.
  11. The Eurozone Continues to Falter…which is not big surprise…But the fix will be…as a few of the PIIGS…”temporarily” depart the EU to get there fiscal houses in order. Meanwhile the Eurocrats continue to punt the ball, ignoring the structural deficiencies of the grand EC/EU/ECB experiment and sit back comfortably in Brussels munching on escargot washed down with some DP. Meanwhile Club Med continues to burn…literally. There are increased indications that one or more of the PIIGS may be forced to depart the Euro ‘temporarily” to get their fiscal house in order…as expected…Greece will get the exodus ball rolling. When this happens I predict that the Euro…now referred to as the DM When Issued…will rally on the news.
  12. Iceland…back in the spring of 2008, before the winds of economic turmoil hit later that year, we warned on CNBC that Iceland was the canary in the coal mine…an early warning signal of pending financial doom..it was. Now it has shed the canary status and is more like a Phoenix rising from the ashes. It , unlike its hapless southern Euro neighbours, does have control over its economic destiny and fiscal sovereignty and after much austerity and repeated devaluations of the krona…they get their economic house in order and Iceland’s stock market becomes one of the best performing in 2011. Jean Claude Trichet and Eurocrats take note! Indeed, Iceland’s stock market has been one of the better performers this year…up about 8% YTD.
  13. South East Asia and Greater China Markets Outperform! Go for the growth! Contrary to the current consensus view that the US equity market will be the place to be and will outperform most global markets in 2011..fund flows will continue to favour those markets whose economies will grow faster than the US..these markets in SE Asia and Greater China will outperform most others. Buy a proxy basket of ETF’s in the region including EWS, EWM, EWH and EWT. And for those willing to add more alpha…add Vietnam..VNM. YTD performance here has been generally good….EWS, EWM, EWT have all outperformed the US YTD…EWH is flat on the year and Vietnam, after the devaluation is down on year…on balance this theme is working…so far…and we expect further outperformance for the rest of the year.
  14. Hong Kong’s Cheung Kong Holdings Offers the First Yuan valued IPO!…this is a very big deal on many fronts. Li ka-Shing’s flagship company begins the monetization process of its PRC land bank by offering a Yuan currency based REIT IPO. By itself the IPO is a big deal but the more significant element is the fact that this is the first Yuan IPO offered ever outside of China. The first of many more to come which continues  the long march toward liberalizing and opening the Chinese Capital Account…a major overdue but welcome event. On the micro level, the IPO was successfully done, but do to poor pricing was not received well in the after market. From a macro perspective this deal still represents one more historic move on the long road to liberalizing and opening up the Chinese Capital Account and moving toward a free float of their currency…a step in the right direction.
  15. China Avoids a Hard Landing! …Barely! And like policy makers here, despite the good news described above, the PBOC only succeeds in kicking the reform agenda down the road and generally Peking policy makers fail to speed up the process and take the much needed steps to liberalize and rebalance their economy toward consumption…and more questions emerge about the health of the PRC banks as NPL’s increase. This prediction is playing out …many short sellers have suggested that the PRC economy is going to implode…so far they have been proven wrong…that should continue. But rising inflation (6% data point expected soon) is a becoming a huge stumbling block and will force the PBOC to continue to raise rates. It may even encourage them to revalue the Yuan with a large one off to help stem inflationary hot money inflows that are catalyzed by the Fed’s ZIRP policies.  So, as expected the health of the banks is beginning to be questioned as NPL’s rise….and we are getting further signs of stress from within the “informal banking” sector where it is estimated that trillions have been borrowed.
  16. China challenges US naval dominance of Important Asian Sea Lanes! ..with launching of their own aircraft carrier (their first) and development of air craft carrier killing missile technology..the Chinese appear to be preparing for challenges to the long disputed (by little discussed) and resource rich Spratly and Paracel Islands as well as a final solution to the Taiwan question. The Chinese are apparently adopting the Teddy Roosevelt diplomatic strategy of “walking carefully, but carrying a big stick!” While all others are focused understandably on events in the Middle East…this long festering flash point is getting flashier! In the past few months we have seen an escalation of hostilities between China and Vietnam in the South China Sea…and China is warning the US to mind its own business. As tensions increase…the Philippines is seeking US arms. With oil prices continuing at higher levels expect these tensions to increase.
  17. Oil Prices Continue to Rise and Move Above $100 a barrel…along with other commodities…as the Fed continues to print and exceeds the QE2 quota of $600bil. This oil rise of course is self defeating as it only causes more disinflation pressure by choking off the nascent consumer resurgence. It could knock 1% off of alot of very bullish GDP forecasts out there currently.  And indeed it did…go to $100 a barrel and indeed it has…knocked 1+% off of overly bullish GDP estimates on Wall Street….so where to now?  despite the move to release SPR reserves today…this is technical and cannot offset the laws of supply and demand…tensions in the Middle East remain heightened..so I would expect a continued underlying geopolitical risk bid to the market at around current levels
  18. The Middle East…after a failed attempt to ally with Iraq…Iran experiences another internal citizen led revolt but this one is more successful in overturning the current regime and ultimately leads to one more democracy in the stormy region. A work in progress as the Arab Spring theme continues to play out in the region…the outcome at this point is hard to predict as events are still unfolding…conclude that it will lead to more oil price instability and perhaps an escalation as rumours of anticipated US ground action in Libya and Syria are now circulating…which may be one of the reasons behind the release of oil reserves today.
  19. Gold losses its glitter!…the “chicken little” catalysts for rising gold begin to slowly disappear in the second half of the year. So far we have been wrong on this one with gold up to $1521 an ounce…but we still have six months to go!
  20. The Best Performing Sector in the US in 2011?…the aforementioned financials…led by the banks and the brokers..followed by the asset managers…but wait for the correction in the first half. Definitely…wait for the correction!

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