After a relatively quiet end to 2010, the new year has begun with a roar, and investors seem overwhelmingly bullish.
Once again, people appear to be concluding that a lot of problems are about to be solved, when that may not be the case at all.
That's not to say that the economy in 2011 won't be better than it was last year, because that's certainly possible, at least for a while.
But at some point I expect higher interest rates will hurt both the economy and the stock market. In addition, we are not out of the woods with regard to the real-estate market, which I believe has another leg lower to deal with, both as a function of higher rates and as a consequence of banks finally being forced to face some of the realities on their balance sheets that their "extend and pretend" strategies have thus far allowed them to avoid.
Wall Street's laws of attraction
As for commodities, the first week of trading tested the nerves of those investors who find them attractive. Not only has the market for "stuff" been weak, but all forms of highflying, speculative, momentum-oriented equities have performed well.I suspect this is doubly hard on the psychology of the commodity investor, since those who tend to be bullish on commodities are probably inclined to believe stocks should have been hit already. After all, in many cases the reason they own commodities is that they believe the stock market is mispriced (for a variety of reasons).
However, this is what often occurs in markets. The things you like get sold, and the items you don't like are embraced. Occasionally, it works the other way around, but it certainly seems more common for the assets you own to act in a way that tests your mettle. Meanwhile, ideas that make no sense, and in which you have no confidence, continue to levitate.
I wish I could explain why that is the case, but I can't.
Of course, I think a lot of those same folks thought the Fed was going to exit its first quantitative easing program early, which it was unable to do. In the release on Jan. 4 of the December Federal Open Market Committee meeting minutes, the Fed noted that it saw the economy not improving fast enough to alter QE2, and I think it very unlikely that the Fed will terminate QE2 prematurely, especially with interest rates rising.
Who says food and oil don't matter?
Nonetheless, people's (shifting) views regarding the Fed's likely course of action, and other financial matters, do have an effect on markets. Just look at how many are willing to ignore the price of food and energy when it comes to inflation statistics. Oil is nearly $90 a barrel and, as I write this, the U.N.'s Food and Agricultural Organization has taken note that food prices are now rising faster than they were in 2008, before the financial world nearly came to an end.It is hard to imagine two things that are more integral to daily life than food and energy. But the fantasy continues that they should be excluded from inflation calculations because they don't directly tie into government money-printing. On the other hand, what does? Virtually nothing except bonds, and perhaps, by extension, stocks.
It is not debatable that money has been conjured out of thin air all over the world, and it is finding its way into the price of myriad goods. Mother Nature has a hand in pricing when it comes to agriculture, but money-printing exacerbates whatever occurs.
However, in spite of "official" views on inflation, the bond market has been sensing something, as it continues to decline from the highs it set before QE2 commenced. At some point, the Fed's life is going to get much more complicated, as it will for those who are now blindly piling into stocks. If I had to guess, I would say that those who are extra bullish on the stock market are going to be disappointed, and I would not be at all surprised if 2011 ended up being a negative year for stocks and bonds.
'What is' trumps 'what if?'
That said, I don't base investment decisions on predictions, because they are rather useless in terms of making (and managing) money. What is far more effective is to be aware of what the major problems are and be alert to signs they are actually beginning to matter. In other words, reacting to the fact that people have begun paying attention to concerns that had previously been ignored is far more profitable than having some big prediction and sticking to it. It can be very painful to invest based on an adamantly held view that such-and-such should be happening just because you have identified a particular problem.
As we have seen, long-festering issues take some time to manifest themselves, whether it was the insanity of the equity bubble, the even greater insanity of the real-estate bubble or the brewing lunacy of trying to print our way to prosperity. Looking across the pond, the problems with Greece were well-known to those paying attention, but the problems didn't matter until they suddenly mattered to everyone.
In short, I think 2011 is going to be a tough year for financial assets, regardless of how it begins.
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