Nobody knows what the future holds. But there are a few things shaping up that suggest certain things will most likely happen. Here are some of the major ones.
Interest Rates: Low at the beginning of the year, then headed higher for a long time. If you have an adjustable rate mortgage and you're still paying it, it's the perfect time to get it refinanced, if you can qualify. Interest rates are definitely going up; it's just a matter of when. As long as the Fed is pumping money in (QE2 is targeted with $800 billion....with the possibility of more behind it), rates will stay low, unless investors think inflation will get way out of hand. Then rates will go higher no matter what the Fed does as investors sell longer term bonds to beat the coming inflation. Initially, rising interest rates will be bullish as they are a precursor to a healthy economy. But that bull will morph and become a bear when rates start jumping as the Fed tries to get ahead of inflation. Tricky business. Investors will do well to have floating rate assets and fixed rate liabilities.
The Stock Market: The basics look good. Earnings are strong. Companies are lean, reluctant to hire until they have to, meaning orders are flowing in so fast they can't keep up with them or tax incentives are strong enough to warrant new employees. With interest rates low, companies can borrow at profitable rates, if they have the demand that warrants borrowing. Many companies have already issued bonds in anticipation of better times. Banks are sitting on large amounts of cash, waiting to loan to creditworthy borrower. The catch is that there's a new definition of creditworthy (as there should be). But parameters are still too tight for most borrowers so money isn't flowing into the economy yet. Bankers will loosen up when they see their loan losses shrink even more. Look for better earnings from large cap companies as they are well positioned to take advantage of positive ecnomic moves. Firms like GE, IBM, F, GM, C, BAC, WFC, JNJ, KO, as well as the airlines and hospitality industries should have a good year. If banks begin to pay dividends again, they'll move up even faster.
The Economy: More jobs, better home sales will lead the way to better times. With lower interest rates, new home sales and refinancings are more affordable. Some companies are adding jobs now (3.4 million jobs were open in October according to the Labor Department...up from 3 million in September). It's happening much slower than anyone wants, but it is happening. As management sees profits lost because of employee shortages, it will hire. As more people get jobs, they'll buy homes. The economic cycle will turn upward.
Domestic and Global Negatives: All of that sounds pretty good. But we all know, it's not that easy to go from the mess we're in to better times. There are plenty of reasons for concern: Europe has weak countries like Greece, Ireland, Spain and Portugal. But it also has strong ones like Germany. Until the governments of each member of the European Union can control their spending to match their revenues, problems will persist. And if the EU decides not to bail out a country, the shock will be felt around the world. How long will the strong countries lend money to the weak ones? If that answer comes next year and is negative, it would split the EU and financial markets would founder.
On the plus side of the global economy: China. It's fighting inflation, supplying the world with goods. It's also importing more and more as the Chinese demand products from around the globe. Turns out they like Buicks, for example. China will go a long way to help all countries with its higher demand for goods and services if it can keep inflation in check.
Domestically, we've lived with low interest rates for some time. Refinancings have most likely been done by those who qualify. New jobs aren't plentiful, and in some industries, they are non-existent. Not everyone can be a programmer or engineer. That's where most of the new jobs are: in the new economy. While low interest rates are good and some jobs are available, many don't qualify for either. Until more basic jobs are filled, the economy will stay slow.
Other foreign affairs: North Korea is rattling its sword. If it gets too foolish, there could be war. That would hurt South Korea's booming economy and lower demand for U.S. goods that were just helped by the new treaty between the two countries. Afghanistan continues to be troubling but seems contained, for the moment. Iran is now talking about its nuclear program but no one knows how long that will last and to what ultimate purpose the nuclear program will be used. The worst is feared here, but dialogue is a good beginning.
In Sum: Just like this year, 2011 is full of promise, full of worry. Investors will do well to lean to the conservative side at the beginning of the year as developments unfold. Watch big banks. As soon as they can start dividends, it means they've passed muster with the regulators to pay some of their precious capital to shareholders. That will mean they need to make more loans to grow again to keep the dividend healthy. That's a good sign the economy is well on its way to better times.
- Ted Allrich
December 7, 2010