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26 January, 2011

Forecast 2011

There has been long times between posts recently, which might be explained by the lower volatility in the markets. Previous posts have simply largely remained in force. Shorting the market has been devastating. I hedged myself by arguing for long commodities and short equities. It has worked out whether one have chosen pure commodity exposure or in the form of shares. Lately,

Before going outright long I will await a larger dip (5-10%). A simple trend line analysis shows that OMXS 30 is trending 40% annualized. Such a rise rate simply can not continue after the initial phase of the recovery and also completed fiscal stimulus / discounted. Now we are also facening budget constraints virtually all over the entire Western world, as well as policy changes in the China locomotive, where a clear shift towards domestic consumption to take place, which would go against earlier policy and be a disadvantage to most western export companies.

But a balanced view is needed on equities. Valuations measures (not adjusted cycle) and continued low interest rates, QE and allocation from bonds to stock market provides support for the markets.

Maybe the 70's scenario should continue to be the main business case, where we move sideways for a decade. Not quite as big rise and fall as during 2000-2010. Budgetary restrictions will be with us for over a decade years. The rebalance of wages all over the world, where emerging market wages increase and western market wages decrease/unemployment increases and government deficits increase as populations demand same service as previous generation. This is highly inflationary in a bad inflation way. Mostly the cost of needs will increase (i.e. energy, food etc). But this is merely a rebalancing of growth from western world to the eastern world. For global companies, this should not be limiting their growth, rather keeping their margins on a sustained high level (this time is different) since there cannot be wage increases in the western world. In addition to this major shift of the global work force, retirement schemes and non-favorable demographics as just adding extra on top of the problems of the west.


When it comes to the S&P 500, one needs to figure out what is a reasonable P/E during these times. Cyclically adjusted P/E's look very expensive and an average of individual years is flawed to look at as well due to the .com bubble. With the S&P near 1300 and profits, at best, around $ 93 for 2011 a P/E  of 14 then gives 1302. P/E 14 does feel a bit on the high side in a scenario where GDP is growing below potential, interest rates are rising, dividends are below historical average, margins are historically high, and fiscal cutbacks kicks in, it feels high to me. But then margins are historically high and maybe not mean reverting any longer because of the structural change described above. Maybe one should view a range of P/E 11-15 as a reasonable measure and trade mean reverting around those levels in a period of very low general growth as well as central bank puts which both caps upside and downside.