What do Santa Claus have in store for us in 2011?
2010 was a year where everyone got something for their money: We had two major crises in the EU in May and again in November / December which gave pessimists a good starting point for more crisis predictions in 2011.
Optimists also had reason to be happy as the stock markets had a good performance especially under the circumstances and the only 'issue' is the ever increasing interest rate, which rallied past the magic 3.00% line yesterday on the 10-year U.S. interest rate.
What should we expect for 2011? Predicting the future or even just a few hours ahead is impossible as this quote explains:
"Legends of prediction er common throughout the whole Household of Man. Gods speak, spirits speak, computer speak. Oracular Ambiguity or statistical probability giver loopholes, and discrepancies er expunged by Faith."
Ursula K. Le Guin
A better less rigid method is to put the odds on different possible outcomes. The world we are in today has historically low interest rates, historically high intervention from policy makers (central banks and politicians).
Scenario 1: Sweet-spot. Odds: 50%
More of the same (as in 2010). Every crisis is met with the printing of more money, however, there will probably be less demand for help than in 2009 and 2010.
The policy makers will maintain the subsidities to the banks through low interest financing and liberal rules for what kind of securiy can be used for colleteral. This gives banks another year with big revenues paid and financed by taxpayers' money.
Bying time. The economy is coming back, but still too weak to create enough jobs, why a rising unemployment rate will keep rates at historically low levels.
Businesses, especially large ones, will use the low yield to expand further in Asia and there will be increased Merger & Acquisition activity and increased consolidation in most industries, which in turn will drive the Price / Earning values up, while top line growth will have peaked in 2010. The shares are up 10-15% end of 2011.
Interest rates are still at the same level as in 2010: 3-4% for the 10-year yields since as there is still too much global capacity.
More and more countries will face demand for higher yields from the bond market. In Europe, because Germany will not or can not increase their support for the EU project, why the trend from 2010 will continue with more and more support from the ECB and other quasi-public enterprises.
In Asia, China will drive interest rates higher through the tightening of monetary policy as necessary after the sharp inflation increase in 2009/2010
Both commodities and metals will continue to grow as the market will be latently skeptical about the lack of structural change in the economies. Everything is seen as "kicking the can further down the road"
Goldman Sachs latest Outlook 2012 is such a sweet-spot forecast.
Risk: Not enough growth to reduce the large structural deficit on the budget and current account balances. The global imbalance is amplified. It's all a matter of buying and getting a little more time to have things work itself out.
Scenario 2: Strong growth. Odds: 20%
The world is ok! Everything is ok. Increased intervention by policymakers is working. It creates greater trust, which again will get the bank lending again, velociteten of money rises, deflation will be averted and the unemployment curve is broken and we're back in what looks like 2006/2007.
Policy makers will make the right combination of fiscal tightening, while they implement the structural changes that is needed for the long-term problems such as demography, lost productivity and government deficits.
EU implements a common fiscal policy anchored in Germany, so we create another round of lower interest rates for PIIGS countries (Portugal, Italy, Ireland, Greece, Spain). These countries are turning their economies from negative growth to 4-5%, almost in defiance.
The stock market rises 30-40%, since the perfect combination of falling unemployment and rising growth expands the Price / Earning ratio, but also the top line growth.
Interest rates are driven up, slowly, but we see interest rates of 5-6% or even 7% in Europe.
There will be exit from many of the stimulus programs that was implemented in 2008-2010, and the private sector is more or less able to take over again from the public intervention.
Risk? A soaring inflation. The combination of loose monetary policy plus rising input prices by commodities and food brings inflation above 3 per cent p.a and get the central banks to tighten monetary policy and the new buzz-word is hyper-inflation. (The stock market will cope with this inflation increase through increased sales volumes, cost control and higher productivity)
Scenario 3: Crisis 2.0. Odds: 30%
We are moving slowly but surely from one crisis to the next. The lack of long-term solutions will be expensive for everyone. The end of 2010 was a precursor for 2011. This is now emergency planning at all times . We may move close to REAL strutural changes in the economy due to the depth of the crisis. (Why is it never possible to make good decisions when you have success?)
This is now full blown crisis of confidence. Both politicians and central banks have lost confidence among investors, corporations and citizens. All public elections are protest elections (as in the 1970s). People want changes without pain, but get pain with new initiatives instead.
This becomes a breeding ground for rising social unrest because the austerity adopted in 2010 will in 2011 be implemented. Unemployment starts to rise sharply, growth collapses again.
The stock market begins a decline that which at the worst point takes it down 40-50%. 'Cash is King'. The gold goes to 3000 U.S. Dollar, USD vs JPY hits 65.00, The Chinese stock market falls 25% in a week, as the Chinese Politburo must change policies to remedy the great social unrest created by higher food prices and no jobs. Again, the rebirth of the new super power has to be stopped prematurely.
The housing market collapses at rates which is fair value, both in relation to purchasing power, but and long-term values. That means 25-50% down from current rates.
There are two interest rates levels. One for those with credit standing which is given relatively cheap funding while PIIGS, none-investment grade and small companies will pay and ever higher and higher interest rates. There are now two societies: One for those who have, one for those who have not. (Think: banks vs. small companies (as in 2009), the Joe Blow blue collar worker vs. high income wage earners with low borrowing). Overall, the interest levels creeps due to the confidence crisis (the marginal cost of capital has reached saturaton point): 7-10% for 10 year yields.
Viewed from 10,000 feet 2011 will be the year where we get "destruction of capital" but also where we finally begin to restore our society.
When we go into 2012/13 it will be with lower leverage in our society, higher equity to foreign capital, better resource allocation, a more balanced society, with less "I". We come back to basic. 2.0 The crisis may be the best in the long run, but who want to undergo the above disorders if it can be avoided?
Predicting from one year to another implies a lot of information bias and linear thoughts, but this Outlook value, if any, is to have thought outside the box.
All three scenarios have realistic chances, and maybe we can even experience all three within a year.
One prediction for 2011, however, I will make, and with strong conviction: In 2011 will be extremely volatile. Don't forget the true defintion of volatility: "... Uncertainty of path '.
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