Start preparing yourself for the bumpy ride in the year ahead
Can You Handle the Truth?
I’d love to be the one to tell you that 2011 with be the year the economy recovers, unemployment declines and the bulls drive up the market. But it wouldn’t do me much good to lie to you, now would it?
While everyone wants to believe that things are on the mend, sticking your head in the sand and hoping for the best is no way to make money. In fact, it’s a great way to lose money. So start preparing yourself for the bumpy ride in the year ahead with these market predictions and trading ideas.
#1 Housing Market Languishes On
Unfortunately, 2011 will not be the year the housing market recovers. Instead it will remain in a state of depression . New home starts will not exceed 425,000, the peak being 1.6 million in 2006. Inventory will hit an all-time high. Home prices will continue to fall nationally. Foreclosures will slow in the beginning of the year, but pick up speed in the second half, delaying the housing recovery until late 2013 or early 2014.
Trade: Short the homebuilders and their suppliers.
#2 Double-Dip Recession Becomes Official
Revised numbers will show GDP growth was less than 2% in 2009, and less than 1% in 2010. Without a housing recovery, there will be no economic recovery, as 40% of all new jobs created in 2002-2007 were related to the housing sector.
Trade: Short consumer discretionary stocks, especially luxury retailers, or this retail ETF.
#3 Unemployment Officially Goes Above 10%
Currently at 9.6%, the official government unemployment number will climb north of 10%. Real-world unemployment, which includes those who have fallen off the rolls, those too discouraged to look for work, and those working part time who want to be working full time, is closer 20%, and will climb another 2-3 points in 2011.
Trade: Go long discount retailers and short payroll service providers like Paychex, Inc. (NASDAQ: PAYX).
#4 Interest Rates Stay Near 0%
The Fed will rely on quantitative easing and ultra-low interest rates to buoy the economy. Bully for them — and for traders. But the Fed’s quantitative easing efforts will slow down mid-year unless there is a full-blown European banking crisis (more on that in a minute), and the market will fall when the pump stops being primed with cash.
Trade: Go long gold and silver, preferably with call options on gold and silver ETFs SPDR Gold Trust (NYSE: GLD) and iShares Silver Trust (NYSE:SLV ).
#5 European Debt Crisis: The Sequel
Another more serious European debt crisis will come to light. I’d say there is a 50% chance of a full-blown financial crisis and a restructuring of Irish or Greek debt.
The Irish will need to borrow money in mid-2011. The European Central Bank (ECB) will continue to be pressured to stop buying Irish and Greek debt (and if not the ECB, who is there to foot the bill?). And when a German takes over the ECB in July, frugality will be taken to a whole new level.
Trade: The euro will fall, as will the pound, so short these currencies, as well as large European Banks.
#6 U.S. Dollar Rebounds
The U.S. dollar will rebound as other currencies fall. While the greenback’s decline has been steep due to expectations of the Fed printing more money, the second leg of the European debt crisis will knock the euro down, which, in turn, will push the dollar up.
Trade: Go long the U.S. dollar via the PowerShares DB US Dollar Index Bullish Fund (NYSE: UUP).
#7 Political Gridlock in Washington
There is gridlock in Washington after the Republicans take the House in the midterm elections. If they stay true to form, they will refuse to put through any initiatives that stand a chance of passing the Senate or being signed by the president. Their main goal will be to secure the presidential race in 2012.
Trade: Short the sectors that will suffer most from political gridlock.
#8 Trouble at the State and Municipal Levels
States and municipalities will accelerate cutbacks and layoffs. The probability of a municipal default somewhere in the United States is about 99%. The probability of a large (population 250,000 or more) city defaulting is about 50% in 2011, and a near certainty in 2012. Cities can go bankrupt and clean out old contracts and obligations; states cannot.
I agree with analyst Meredith Whitney that at least 500,000 to 1 million public workers will get the ax. This will lead to cries for more assistance from Washington, which will not be forthcoming until the election is in full swing in 2012.
Trade: There is no real trade here.
#9 China Becomes a Serious Problem
The Chinese don’t get it. They have destroyed industries around the world. They enabled North Korea to develop and then export nuclear weapons and know-how to Pakistan and Iran, and then said, “We are your friends, help us, we cannot afford to revalue or cut back on exports.”
The developed world will hit a political tipping point and the trade barriers currently being erected out of sight will become more visible. China will do a small revaluation that will have no impact, and then things will get nasty as the year ends and the presidential primaries draw closer.
Trade: Short China ETFs and companies deriving more than 10% of their profits from Chinese operations.
#10 Corporate Profits Fall, and the Market Along With Them
All of the problems I have just discussed will lead to further economic hardships, which means depressed demand for many products and services provided by corporate America. As growth stalls (in fact, it already has for most companies), profits will fall. As corporate profits fall and quantitative easing slows, the market will drop, probably sometime in Q1. The higher the market is at this point in time, the sharper and faster the decline.
A manageable decline and continued QE through mid-year brings the S&P 500 down to 925-985. A sharp decline, and an unexpected pullback in Fed easing or a major financial crisis, brings the S&P down to 725-785. A financial panic brought on by a European bank crash brings the market down to 585 to 615 for a very brief period, and then back to around 725.
Trade: Hedge all long positions with a macro put option position on the market, such as SPDR S&P 500 (NYSE:SPY) puts. Once the mood turns sour and the market heads south, trade double inverse ETFs, and if you can stomach the risk, buy calls on them.
#11 Giants Go to the Super Bowl
That’s right, the New York Giants will go all the way this year. And this time, I find the cash to go, which, of course, means they will lose.
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