There are forecasts everywhere of better times ahead in terms of employment, retail, inflation, GDP. David Rosenberg is having none of it. He sees the market as heavily propped up by the Fed. This is his look forward for 2011.

~~~

1. In Barron’s look-ahead piece, not one strategist sees the prospect for a market decline. This is called group-think. Moreover, the percentage of brokerage house analysts and economists to raise their 2011 GDP forecasts has risen substantially. Out of 49 economists surveyed, 35 say the U.S. economy will outperform the already upwardly revised GDP forecasts, only 14 say we will underperform. This is capitulation of historical proportions.
The last time S&P yields were around this level was in the summer of 2000, and we know what happened shortly after that.

2. The weekly fund flow data from the ICI showed not only massive outflows, but in aggregate, retail investors withdrew a RECORD net $8.6 billion from bond funds during the week ended December 15 (on top of the $1.7 billion of outflows in the prior week). Maybe now all the bond bears will shut their traps over this “bond-bubble” nonsense.

3. Investors Intelligence now shows the bull share heading up to 58.8% from 55.8% a week ago, and the bear share is up to 20.6% from 20.5%. So bullish sentiment has now reached a new high for the year and is now the highest since 2007 ― just ahead of the market slide.

4. It may pay to have a look at Dow 1929-1949 analog lined up with January 2000. We are getting very close to the May 1940 sell-off when Germany invaded France. As a loyal reader and trusted friend notified us yesterday, “fighting” war may be similar to the sovereign debt war raging in Europe today. (Have a look at the jarring article on page 20 of today’s FT — Germany is not immune to the contagion gripping Europe.)

5. What about the S&P 500 dividend yield, and this comes courtesy of an old pal from Merrill Lynch who is currently an investment advisor. Over the course of 2010, numerous analysts were saying that people must own stocks because the dividend yields will be more than that of the 10-year Treasury. But alas, here we are today with the S&P 500 dividend yield at 2% and the 10-year T-note yield at 3.3%.

From a historical standpoint, the yield on the S&P 500 is very low ― too low, in fact. This smacks of a market top and underscores the point that the market is too optimistic in the sense that investors are willing to forgo yield because they assume that they will get the return via the capital gain. In essence, dividend yields are supposed to be higher than the risk free yield in a fairly valued market because the higher yield is “supposed to” compensate the investor for taking on extra risk. The last time S&P yields were around this level was in the summer of 2000, and we know what happened shortly after that. When the S&P yield gets to its long-term average of 4.35%, maybe even a little higher, then stocks will likely be a long-term buy.

Source: Haver Analytics, Gluskin Sheff

6. The equity market in gold terms has been plummeting for about a decade and will continue to do so. When measured in Federal Reserve Notes, the Dow has done great. But there has been no market recovery when benchmarked against the most reliable currency in the world. Back in 2000, it took over 40oz of gold to buy the Dow; now it takes a little more than 8oz. This is typical of secular bear markets and this ends when the Dow can be bought with less than 2oz of gold. Even then, an undershoot could very well take the ratio to 1:1.

7. As Bob Farrell is clearly indicating in his work, momentum and market breadth have been lacking. The number of stocks in the S&P 500 that are making 52-week highs is declining even though the index continues to make new 52-week highs.

8. Stocks are overvalued at the present levels. For December, the Shiller P/E ratio says stocks are now trading at a whopping 22.7 times earnings! In normal economic periods, the Shiller P/E is between 14 and 16 times earnings. Coming out of the bursting of a credit bubble, the P/E ratio historically is 12. Coming out of a credit bubble of the magnitude we just had, the P/E should be at single digits.

Source: Haver Analytics, Gluskin Sheff

9. The potential for a significant down-leg in home prices is being underestimated. The unsold existing inventory is still 80% above the historical norm, at 3.7 million. And that does not include the ‘shadow’ foreclosed inventory. According to some superb research conducted by the Dallas Fed, completing the mean-reversion process would entail a further 23% decline in real home prices from here. In a near zero percent inflation environment, that is one massive decline in nominal terms. Prices may not hit their ultimate bottom until some point in 2015.

10. Arguably the most understated, yet significant, issue facing both U.S. economy and U.S. markets is the escalating fiscal strains at the state and local government levels, particularly those jurisdictions with uncomfortably high pension liabilities. Have a look at Alabama town shows the cost of neglecting a pension fund on the front page of the NYT as well as Chapter 9 weighed in pension woes on page C1 on WSJ.

Consumer spending was taken down 0.4 of a percentage point to 2.4%, which of course you never would have guessed from those “ripping” retail sales numbers.

In the absence of Chapter 9 declarations or dramatic federal aid, fixing the fiscal problems at lower levels of government is very likely going to require some radical restraint, perhaps even breaking up existing contracts for current retirees and tapping tax payers for additional revenues. The story has some how become lost in all the excitement over the New Tax Deal cobbled together between the White House and the lame duck Congress just a few weeks ago.

Category: Markets

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

20 Responses to “10 Reasons to be Cautious for the 2011 Market Outlook”

  1. DebbieSmith says:

    This article shows how well a decade of quantitative easing has worked for Japan and how the Nikkei 225 Index is well below the level it was at when the Bank of Japan’s experiment started in 2001:

    http://viableopposition.blogspot.com/2010/11/quantitative-easing-learning-from-japan.html

    I can’t imagine how Mr. Bernanke thinks that the outcome from his QE2 experiment will be any different. If investors think that QE2 is going to be the best friend that the market could possibly have in 2011, we’d all better think twice.

  2. Jack Damn says:

    I enjoyed the article. Lots of good points. One thought of my own …

    7. As Bob Farrell is clearly indicating in his work, momentum and market breadth have been lacking. The number of stocks in the S&P 500 that are making 52-week highs is declining even though the index continues to make new 52-week highs.

    I’m sure Bob Farrell is better at this than I, but I’ve done my own research in the area of “New Highs/Lows”, and a declining number of stocks reaching 52-week highs as the market moves higher is does not seem to be an indication of a market top. At best, a possible correction, but even that seems to be a low probability trade.

    I have found when using 52-week “Highs-Lows” as a measure, what needs to happen during major tops is a rising or consolidating market as New Lows expand … you need new lows to expand against a rising market before a topping pattern can begin. Not just the divergence of New 52-Week Highs vs. a rising Index.

    I don’t see New Lows expanding against a rising or consolidating Index yet.

    I do see fewer 52-week highs, but no clean expansion of new lows (no “smart money” selling). I do see almost 90% of the S&P500 stocks are trading above their 200-day Moving Average ( chart: http://chart.ly/qts9e3p ) which could be an indication of short term exhaustion, but as that chart shows, that overbought level can exists for months. It usually corrects down (or up) to 50% before the trend resumes.

    The absences of New Highs against a rising market doesn’t appear to be enough to indicate a potential top, and actually, during a trend (bull or bear), such divergences seems to happen now-and-then without much pain. I’ve linked to my chart here before, but here it is again:

    » http://kas.tumblr.com/post/1065397343

    The past two tops formed as New Lows expanded greatly against a rising or congesting market. Again, I could be wrong. I’m sure Mr. Farrell has more resources and experience than me, but I thought I’d toss in my 2 cents.

    =^.^=

  3. louis says:

    #9 is most likely going to happen. HAMP is a bust as evident by yesterday’s drop out numbers. They refuse to fix the original problem. The chatter about fixing it has vanished like a fart in the wind.

  4. ToNYC says:

    Does anyone need to be reminded how a crack party ends? QE2 is crack currency and sooner than later the rocks will smoke like just baking soda.

  5. Lord says:

    So I see the market has no place to go .. but up, since the market always likes to move in the unpredictable direction and these always take longer to work out than anyone imagines.

  6. wally says:

    “Coming out of the bursting of a credit bubble, the P/E ratio historically is 12. Coming out of a credit bubble of the magnitude we just had, the P/E should be at single digits.”

    The problem with stats like this is that, today, everybody knows stats like this… so they front-run to try to anticipate. Then the stats are no longer valid. Rules about the markets are moving targets.

  7. louiswi says:

    Debt is always paid. It is paid by either the borrower (desired outcome) or the lender (not so desired) or a combination of the two-ALWAYS.

    The commentary so far seems to be a mix of the economy and the markets. Regarding the economy:

    It seems easiest to consider the current economy much like a giant cauldrin filled with economic activity. At the bottom is the drain and out of that drain goes all kinds of mostly failed activity (destructive capitalism) such as bankruptcies, fraud, other criminal activities, re-pricing activity and general inefficiencies. At the top of the cauldrin are the faucets and among those faucets which include productivity, general economic efficiencies, capital spending and government spending activities. Another faucet is the federal reserve. The purpose of all this is to keep the pot rolling and boiling to the tune of about 13 plus trillion dollars called the GDP and actually have it advance by a few percentage points each year. Most of the activities at the top of the cauldron and below it happen by normal human inputs with the exception of the Federal Reserves role. Their single role is to keep the pot from becoming empty as well as to keep the pot from over-flowing. So far, they have done a masterful job. There is not a reason they cannot continue to do this. At some point, the stuff going down the drain will lighten up. Our only real concern is will the Federal Reserve detect this in time so as to not allow the pot to overflow. A lessor although real concern is well meaning nabobs convincing the Fed to give up on this and allow the cauldron to go empty. Whether it is QE1 or QE111, it won’t make any difference.
    Regarding the stock market, it might go up and then down or equally it might go down and then up. That is difficult to assess.

  8. 6. The equity market in gold terms has been plummeting for about a decade and will continue to do so. When measured in Federal Reserve Notes, the Dow has done great.

    QOTD:

    “I sincerely believe, with you, that banking establishments are more dangerous than standing armies; and that the principle of spending money to be paid by posterity, under the name of funding, is but swindling futurity on a large scale.” -Thomas Jefferson (letter to John Taylor in 1816)

    10. Arguably the most understated, yet significant, issue facing both U.S. economy and U.S. markets is the escalating fiscal strains at the state and local government levels, particularly those jurisdictions with uncomfortably high pension liabilities.
    ~~

    nice Post, DR~

  9. Patrick Neid says:

    The macro and the trading views are often two very different and difficult outlooks to consolidate. While it is almost impossible to argue against the bear view, post bubble, it is not a good trading view. As a result it is not hard to see the S&P testing the all time highs before turning back down hard. It has done it before and it will most assuredly do it again. Trading the move is the hard part. Rosenberg’s brilliant analysis over the last year and a half has been no help in this regard as to stocks in general.

    With bullishness at these extremes the market has to accelerate or die!

  10. philipat says:

    DR is excellent and I always read his material as part of a balanced spectrum of opinion.

    At present, Jim O’Neil, whom I also greatly respect as a guy who doesn’t mince his words, is on the other end of the sepectrum with Uber-bullish views.

    Sad reflection of the times but, on balance, I have to give more credibility to the “Other than GS” opinion.

  11. jpmist says:

    “10. Arguably the most understated, yet significant, issue facing both U.S. economy and U.S. markets is the escalating fiscal strains at the state and local government levels, particularly those jurisdictions with uncomfortably high pension liabilities. Have a look at Alabama town shows the cost of neglecting a pension fund on the front page of the NYT as well as Chapter 9 weighed in pension woes on page C1 on WSJ.”

    Can’t we nip this distorted piece of nonsense in the bud? Another false meme that is getting repeated into factual status when it’s not even close.

    The NYT’s busted pension article drew the wrong conclusions. What they should have stressed was that it took over 10 years and a bankruptcy for the payments to stop. The amount was a mere $150k a month. So, yes there will be blowups, but they’ll be small relative to the overall muni market and they won’t come as a surprise.

    The recession has been officially over for a year, the equity market has made up it’s Lehman crisis plunge on strong corporate earnings for the last 4 quarters. I concede that municipals will be on the trailing edge of this recovery, but the bottom has passed.

    Fitch has an excellent panic-free factual analysis here:
    http://www.naic.org/documents/committees_e_rating_agency_101118_hearing_fitch_doc7.pdf

    “Governments have captive tax bases and strong control over taxing and spending, and bond security for general obligation and dedicated tax bonds is very strong.
    Debt levels for U.S. local and state governments are relatively low, with annual debt service representing a relatively small part of budgets.
    All but one state and some local governments have some form of legal balanced budget requirement. While there are some notable occurrences of governments incurring and carrying large accumulated deficits, they are rare.
    Although Fitch recognizes that history is no guarantee of future performance, there is a long record of governments making difficult choices to maintain budget balance while making full and timely debt service payments even in very stressful financial situations. Outstanding municipal debt is estimated to be $2.7 trillion. Over the past 10 years, annual issuance has ranged from $287.2 billion$429.9 billion. The 10-year cumulative default rate through 2009 for all rated municipal bonds, including those rated below investment grade, ranges from 0.04%- 0.29% based on reporting from all three major rating agencies.
    Many states have procedures in place for a locality to address problems well before a debt service payment would be in jeopardy, providing a buffer between financial strain and default that does not exist for corporate credits.
    Bankruptcy (when permitted by a state) relegates decisions to a judge and is costly, time consuming, and unpredictable given limited precedents, making it a relatively unappealing option for local government issuers. States cannot file for bankruptcy protection.
    Pensions clearly represent a growing spending pressure and a large long-term liability that for some constitutes a major credit issue. Additionally, the investment return assumptions for most systems, a by-product of past performance, now appear somewhat optimistic. However, most state and local governments have been making payments towards their projected long-term liabilities for decades, resulting in sizable pension trust balances and significant actuarial funding for most plans. Broadly speaking, significant adjustments to plan benefits and contributions will be required, and in some instances such changes are already underway. Since unfunded obligations in most cases are not due for many years, issuers have the opportunity to make these difficult adjustments.
    Fitch’s ratings for tax-backed credits do not assume a federal government backstop for state or local government credit. Such support on a broad basis or for any individual entity as a last resort action would be highly situational, unpredictable, and precedent setting. In addition, due to U.S. constitutional separation of powers, the federal government’s power to affect state operations and obligations is limited.
    Fitch believes that the coming years will involve many difficult choices for state and local governments as they consider the level of taxation, government services, and public sector compensation that can be supported. However, for the reasons outlined here, Fitch believes that legal and practical bondholder protections will continue to be strong in this environment.”

  12. machinehead says:

    ‘Maybe now all the bond bears will shut their traps over this “bond-bubble” nonsense.’

    Earth to ‘Rip van Winkle’ Rosenberg: Dude, that comment is so four months ago! The ‘bond-bubble’ Cassandras — of which I was one — were dead-on right: since late August, when we were screaming danger, bonds have taken a horror-show shellacking — the worst bloodbath since 1994.

    Feast your eyes — if you’ve got a cast-iron stomach — on this gut-wrenching chart of the long-bond ETF, symbol TLT. Its share price has dropped nearly 15% since its August peak:

    http://bigcharts.marketwatch.com/quickchart/quickchart.asp?symb=tlt&sid=0&o_symb=tlt&x=0&y=0

    So yes, in the aftermath of the fixed income meltdown, retail peeps are finally, belatedly fleeing bond funds after losing more money in a hurry than they ever imagined possible.

    But that’s okay, David — we early-and-correct bond bears are used to getting no credit for our timely calls. Carry on with your grand revisionist history — don’t mind my annoying little footnotes! ;-)

  13. mark says:

    @jpmist

    Fitch? Really? A rating agency report? Really? The same guys that reiterated Fannie’s AAA rating on Oct 31, 2007?

    And Rosie made his call on housing back in 2005 as I recall. So I’ll go with Rosie and you go with the guys who did such a great job before. But hey, who am I kidding? You got big Ben on your side so maybe I should go with the Bailout 2.0 too.

  14. barrister999 says:

    Rosenberg, the perma bear, growls again. Unfortunately, he hummed the same tune last year. Everytime I read an article jammed full of statistics, whether they be macro econ stats or market stats, I can’t help but recall Benjamin Disraeli on statistics: There are three kinds of lies: lies, damned lies, and statistics. Or Mark Twain: Facts are stubborn things, but statistics are more pliable.

  15. cognos says:

    Rosenberg = broken clock.

    This is pretty much exactly the same thing he said in June 09 at 850 on spx. Div yield is not high enough, bah! It’s just idiotic, earnings will continue to trounce expectations into 2011.spx will like do $100/shr, raise divs, increase buy backs, increase hiring.

    It’s so simple. It’s a recovery. Please position your portfolio accordingly.

  16. [...] The bears have capitulated.  (Business Insider, Big Picture) [...]

  17. victor says:

    About louiswi comment: “Debt is always paid. It is paid by either the borrower (desired outcome) or the lender (not so desired) or a combination of the two-ALWAYS” This is right on but isn’t there a third party here?: when the lender is too big to fail and cannot pay the loss, that same too big to fail lender who gladly fed at the profits trough, cries uncle and guess who comes to the rescue? Well, Uncle Sam himself armed with freshly borrowed moola from China, generated by the millions of Chinese ex-peasants now employed as factory workers earning wages 90% less than their counterparts here…long live Socialism American Style: private profits, socialized losses.

    Rosenberg’s bearish comments are OK, of course the market IS aware of his 10 points, but she has her internal clock, that NOBODY can see short term anyway; nice reading, capital is always at risk, what else can we do? are we supposed to time the market? Could Mr. Rosenberg reveal HIS asset allocation? Mine is still 40% equities, 60 % Bonds + Cash. When bond funds crash, the crash actually helps if dividends are reinvested at lower prices, right? Finance 101?. Happy New Year!

  18. NormanB says:

    Tell us BR: Who the f— is David Rosenberg and what the f— is his track record?

  19. mcc99 says:

    The way I see it… speaking not as someone who picks stocks but looks at the Big Picture in the market because that’s speculative enough all by itself… look at where the Dow and S&P have been these past couple years. Except briefly in 2009 when it collapsed into 6000 territory and raced back up, the Dow has channeled roughly between the high 9000s and high 11000s and that’s it. Breaking out to 12500 for a longer period of time? Look, if you want to play trader, go ahead and watch the market daily, make trades weekly, whatever. But if you are looking to buy into an index fund in Jan 2011 and then maybe sell in Dec., where do you think an index of Dow or S&P500 will be? Gut check. Will either have done well enough to justify the risk? What will you get, really? 5%? If you’re lucky? Where will the Dow be at on 12/20/2011? Will it still be in the mid-11000s? Mid-12000s? Mid 13000s? Or will instead there have been a sell-off? Tell me, why hasn’t it done better? The housing mess, you answer. The banking mess, you answer. Will those two things be cleared up this year? What do you think? So let’s say these indexes do go up, what is that then to you, an 8%-14% ROI OK, if you are topping 8%, you are doing better enough than bonds maybe to place some of what you got into stocks. But 14%? Do you REALLY think they will do that well? Will they top 10%? Hmmm?

    That’s how I see it. Am I Chicken Little? Maybe. But I sleep well at night.