Wednesday, December 29, 2010

Economic and capital market outlook by William Greiner

Economic and capital market outlook by William Greiner : The structure of our annual outlook this year will be broken into two writings. The first installment, contained herein, focuses solely on the cyclical, short-term economic and capital market outlook. In this piece, we describe three economic scenarios, and assign probabilities to each outcome. We also highlight our view toward the U.S. equity market and provide some guidance and thoughtful points that may help investors as we come into 2011.

The upcoming second installment will focus solely on the longer-term secular problems with which our financial system and the world economy struggle to balance. In this piece, we will outline the “Black Swan” concept, and why we believe we may be entering the final phase of the long, drawn out secular bear market, in which the world’s investors have endured.B ut first – Back to Trend Growth…

Executive Summary

Difficult calls. This is what forecasting is all about. It is never easy – if it were, economists and market forecasters would be more correct. This time around, forecasting the economy is particularly difficult due to the extreme disparity between the western world’s income statement (GDP growth) and balance sheet (deficits). The following details our base case, along with the “tail” influences that we believe have the ability to severely impact the economic base case and throw our forecast into a cocked hat.

First, the base case. The recession is over. We made that call in the summer of 2009. Now that most agree, we are entering another phase of this economic cycle. We have left the economic recovery phase of this cycle and are entering the economic expansion phase. With this in mind, we believe the U.S. economy on a “real” basis will grow by 2.9 percent to 3.4 percent during 2011. If correct, this will lift GDP to a new high level of production, above the old high seen in 2007. In this call, we believe consumption expenditure will rise, along with capital spending growth rates. Inflation risks should rise, along with interest rates. About the only things we see not rising are unemployment and the dollar.

Stimulus (either through Federal Reserve activity or through lowering tax rates) will provide the catalysts that should spur final demand. The deleveraging of the economy should continue, but at a lesser pace than has been the case for the last three years. Personal savings rates should rise, but corporate cash accumulation rates will probably slow. Overseas, GDP growth on a world-wide basis should eclipse the U.S. rate as the economic juggernaut in Asia and South America continues to roll. It appears to us that world-wide GDP growth should exceed 3.5 percent for 2011.

Lastly, we believe the U.S. stock market (as measured by the S&P 500 Index) may rise to a high of 1350 during 2011 (we believe the downside risk in market values may be as low as 1100). Driven by earnings growth, and spurred by investor optimism, we believe this high may be reached during the first nine months of the year. We believe, due to our call of a falling dollar and strong regional GDP growth rates, foreign investment may outperform domestic investment.

While all that has been said may lead one to the conclusion that we are expecting sunny economic and market skies, we see storm clouds on the horizon – issues which will not and cannot go away. These storm clouds have continuously been on the horizon (or overhead) during the last three years. These issues center on our favorite whipping boy – debt and levered balance sheets. Let’s face it – an environment where the Federal Reserve needs to employ a “QE2” strategy is not normal. The economic sands are still shifting, with world-wide GDP composition rapidly changing combined with excessive levels of debt. This combination is proving deadly for market and economic stability.

From a secular, long-term standpoint, we continue to believe the U.S. (and the majority of the world’s capital markets) remains in a long-term bear status. With this in mind, gains in capital markets may indeed be fleeting. An active, trading-oriented mentality at times makes sense. Additionally, maintaining cash balances in portfolios for “offensive” reasons may be productive. After all, volatility brings opportunity. One needs available, fresh capital to take advantage of such opportunities. Our stance in a nutshell: it is time to take advantage of what the capital markets may offer over the near term, as we wait for the next Black Swan to arrive. Read More...
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