January 02, 2011

2011 Economic Themes

Making market predictions is a fools game.  There are too many moving parts, all of which can change rapidly, especially in a highly-charged political environment.  The smart observer / investor will, instead of trying to predict the course of the markets, evaluate probabilities and position appropriately, with a willingness to change one's overall thesis upon shifts in the financial landscape.

The starting theme for 2011 is one of a continuation of 2010, as the Fed is still doing QE.  Avoidance of dollar-denominated financial instruments, with wealth preservation as a focus, is still proper positioning.  The one thing to note is that all risk assets are well overdue for a correction, so I also believe that a hedge is warranted at this time.  Because of the difficulty of timing, I think cash is a bad idea, as we could easily see a further run-up in assets prior to a correction.

Going forward, the new Congress will play a major role, especially as we approach the current ceiling on the national debt.  This will be a major issue from the middle to the end of the first quarter, and could easily cause the long-awaited correction in risk asset pricing.  Also, at that point, QE2 will be about half completed, and the markets will be wondering about the Fed's next move.  Should a correction occur at this point, an investor is going to need to pay close attention, as possible policy paths would have widely divergent economic results.  We could correct and have a strong bounce, keep going down, or even never correct at all depending on which moves are made by Congress and the Fed.

To be honest, looking past this critical period is mostly a waste of time, as there are so many variables in play and a large number of possible outcomes.  Still, assuming we make it through relatively unscathed, that the policymakers largely preserve the status quo (with further economic can-kicking), the rest of the year is likely to return to a repeat of the 2nd half of 2010.  This would set us up for a 2012 disaster as, with gas breaking at least $4 / gallon and food inflation starting to put a huge dent in the average wallet, the election year would likely turn into economic and political chaos.  It probably will regardless, as there will be major economic pain somewhere -- a continued decline in housing prices, pension fund collapses, state and municipal defaults are all possibilities, especially if we don't go the inflationary route.

In short, I expect to see some first quarter fireworks, followed by a relatively tame rest of the year.  I wouldn't be at all surprised to simply maintain a wealth preservation portfolio, hedged with puts, throughout 2011.  2012 is where I expect the major issues to finally come to a head (damn those Mayans).  There are so many possible exogenous factors, however, that pretty much anything is possible.

Other areas to watch for are:  a possible Yen crisis, if Japan finally runs out of the ability to increase their national debt through the looting of the savings of their own citizens; a possible Euro crisis, if Spain or Italy blow up, or if Ireland gets balls and tells the EU to fuck off; a China crisis, if inflation takes further hold there, forcing some combination of capital controls, price controls, interest rate hikes, and/or Yuan revaluation.  Or, some global hot-spot (North Korea?  Iran?) could blow up and we could have an expansion of global conflicts.  There are more than enough potential plummeting black swans to keep everyone ducking for cover throughout the year, so even though I expect 2011 to be mostly calm before the storm, I'll do my best to be prepared for as many eventualities as possible.

Posted by: Hermit Dave at 02:40 PM | No Comments | Add Comment
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