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Saturday, December 18, 2010

2011 Predictions and Investment Themes

Hal Blackwell’s Predictions for 2011
On my website I claim the title “futurist”. No state or federal license is required to make the claim but a list of predictions for the coming new year is mandatory. Without further adieu:

1. The financials, with Bank of America leading the way, will be the best preforming sector on the NYSE in 2011. 
With the Fed Funds rate stuck at zero and the Federal Reserve unsuccessfully battling to keep mortgage rates low, the spread between short and long term rates will widen. The wider the spread, the more money banks make. Banks making historic profits borrowing money from the Federal Reserve for free will continue to be satisfied with the bounty earned by investing in “risk free” treasury debt. Banks will not have to lend money into the economy to make outrageous profits. Usually increased profits at financial institutions bode well for increased lending but not in 2011. Mortgage “put back” fears are overblown.
2. Unemployment will rise to 11%.
The stimulus created in the new tax measures recently approved by Congress will keep the unemployment rate steady at 9.7% through the first two quarters of 2011. But as that stimulus begins to fade and Republicans threaten to cut spending, the economy will start to turn south again. Cuts by state and local governments will add to the ranks of the unemployed. 
3. Jim Demint will emerge as a front runner for the Republican presidential nomination.
Demint has built his political career on the principles that are gaining favor with independent voters. Very few Senators can say, “I told you so!” Demint is presidential, comes across as trustworthy and is smart. He can also raise a cazillion dollars from the Tea Party constituents at the drop of a hat. 
4. The Mexican government suspends the writ of amparo (Mexican hebeas corpus) in a last ditch effort to hunt down and destroy the drug cartels and avert complete anarchy. 
The drug cartels will continue to operate with complete immunity in Mexico. The rule of law in the country will become subjugated to the indiscriminate violence and corruption. As the conflict deepens the trickle of illegals coming across the US border turns into wave of refugees.
5. The state of California will end the year in dire need of a bail out.
Another decline in the real estate market coupled with refugees coming across the Mexican border will put a sever strain on state and local governments. There will be a record number of defaults on municipal bonds in California and the cost of borrowing will force federal intervention in 2012.
6. The Real Estate market will take its final leg down.
“Water treading” in the Real Estate market comes to an end. The number of foreclosed properties going on the market coupled with higher mortgage rates (despite QE2) will finally drive the market to its bottom.  
7. Merger and deal activity on Wall Street will have a record year. 
As inflation fears creep into the board room, the piles of cash sitting on corporate balance sheets will be used to vertically and horizontally integrate. Some really strange partnerships emerge as organizations desperately look for places to invest mountains of cash. 

8. House Republicans play politics and refuse to make any hard decisions preparing to take on Obama in 2012. 
Our political leaders stay in power by demonizing the other side of the isle. We are likely to see some government shutdowns and other rhetorical moves to claim the moral high ground to impress the political center. Nothing of substance will be done to address the deficit.

9. The European sovereign debt crisis continues to boil under the surface. 
The German’s are on record as saying they will stand behind their Euro partners. We can expect a bailout in Italy, Spain, Portugal, Ireland (again) and possibly Belgium. The German’s should be able to “kick the can down the road” for at least one more year. If there is a “restructuring” of Spanish or Italian sovereign debt all bets are off. The second great financial collapse (the Great Depression was the first) will be under way in earnest. Such a “restructuring” would be the death of the Euro and signal that the ECB’s best efforts (along with secret Federal Reserve assistance) were unable to prevent such a calamity. The European banks are loaded down with Euro denominated sovereign debt.
10. Civil unrest in Europe will escalate dramatically.
As European governments face economic reality; their populace will still deny the certainty of arithmetic. Denial of services most Europeans view as entitlements will spur an ever larger segment of the population into the streets.
11. The China story will take a different turn as its economy begins to overheat.
China is in the midst of a real estate bubble. As the government tries to reign in inflation by raising rates there is a good chance this bubble will pop. The Chinese government, flush with cash, will be able to cope with the collapse but this will put dramatic deflationary pressure on the global economy. As inflated commodity prices revert to the mean, the imminent danger of global deflation looms as 2011 comes to a close.
12. The Korean peninsula will be reunited as the North Korean government collapses under the strain of China’s pressure and dissension within the military.
After a short and desperate military action the North Koreans will have their towel thrown in for them by the Chinese. The DMZ will be flooded with refugees as the world pours aid into the North.
13. The Iranian’s will explode a nuclear devise or demonstrate a “dirty bomb” ballistic missile capability. 
The Iranians will gain a nuclear devise or a “dirty bomb” capability. The world will come to know what the “Mahdi” is and why it is important. Tehran will start the first phases of a campaign to hold the world hostage in an attempt to destroy Israel. 
14. The war in Afghanistan fails.
The Obama Administration’s proclaimed date of withdrawal coupled with a lack of commitment to “win” the war, will be the key to the demise of US efforts there. The President will attempt to declare victory and leave. The White House will use verbiage similar to “we have done all we can do”. Obama’s dependency on the far left wing of the democratic party will demand a US withdrawal and politically he will have no other option but to withdraw US forces.
15. The Obama administration will descend into chaos.
In an effort to bolster his reelection prospects the President will make a schizophrenic move to the political center. The left wing of the democratic party will threaten to run primary opposition. Several candidates on the left of Obama will emerge.  A crisis along the Mexican border, as violence spills into Arizona and California, and rising unemployment will reveal political miscalculations and core incompetencies within the administration. The Obama presidency will be rendered powerless to deal with these escalating economic and national security challenges.
Note: Do not be surprised if the White House is rocked with scandal. There has been too much money flowing through government and too much ill will in powerful places.
Signs my predictions are coming to pass will include the following:
  • A significant run up in the S&P 500 (1,243 currently) to 1,390 occurs as bond holders sell due to inflation fears and insufficient yields in the fixed income arena. 
  • Interest rates begin to rise as the debt market demands higher yields. Higher interest rates choke off the anemic recovery.
  • The Federal Reserve announces QE 3 in late summer as the optimism sparked by the stock market’s run up fades.
  • Summer 2011 brings increased volatility back to the market.
  • Market sells off in late September and early October 2011.
Signs that I am completely off my rocker:
  • If the move up in the financials is confirmed by increased revenue within the transportation sector. This would mean I am way off base!
  • The US Treasury curve starts to flatten.
  • The price of gold collapses.
  • Interest rates start to decrease at the beginning of the year.
  • The Chinese government quits trying to curb inflation.
  • The US dollar strengthens significantly.
  • Inflation fears subside in the first and second quarters.
  • The price of oil decreases in the first half of the year.
  • The Iranians allow complete inspections of their nuclear facilities.
Summary: Predictions for December 31, 2011 
S&P 500 950
Dow Jones 10,000
10 year US Treasury Yield 2.45%
Spot Gold Price $2,300
GDP 2.5% 
Investment themes for 2011
  • Buy gold on the dips
  • Buy US financial institutions too big to fail (Bank of America, JP Morgan, Wells Fargo, Morgan Stanley Smith Barney, AIG)
  • Short high yield muni bonds
  • Lighten fixed income portfolio now, hold the cash, when the yield on the 10 year US Treasury goes under 3.1% mid year, start dollar cost averaging on the long end of the curve
  • Dollar cost average into high dividend paying large US cap stocks. On brisk moves up in the market buy put leap options 15% out of the money (they should be cheap during the first half of the year)
  • Increase emerging market exposure, Brazil, Argentina and Australia  
  • Remember to always hedge, even I am wrong now and then!
Final note:
I know this is a dreadful forecast. It is, however, based on sound economic principles and one common sense axiom of life- “there is no free lunch”. To think America can borrow trillions of dollars, default and walk away having only paid the price of an extended period of 9.7% unemployment ignores the laws of nature. To think we have paid a penalty commensurate with our folly is to deny the ying and yang of the universe. Sorry.

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