BEING STREET SMART

by Sy Harding 

Street Smart's Forecast For 2011! December 31, 2010.

It’s that time of year for my forecast for next year.

But first, how did my forecast for 2010 work out?

A year ago there was considerable excitement about the recession having ended the previous June, and the stock market surging up in a dramatic new bull market off its March, 2009 bottom.

But I predicted that 2010 would see a return of problems; for the real estate sector once the tax rebates for buyers expired in the spring, that loan defaults and home foreclosures would continue to rise, that unemployment would continue to rise, that consumers would remain hunkered down. So economic growth would be anemic and the economy might even slip back into recession for a quarter or two.

Most of that came to pass, except that while economic growth slowed enough in the summer to panic the Fed into promising, and then providing, another round of quantitative easing, the economy did not quite dip back into recession, economic growth slowing only to 1.7% annualized in the second quarter at its worst.

On the stock market, I predicted it would run into a serious correction during the market’s typically unfavorable season beginning at the end of April, but that the most important feature of the year would be “an important bottom, which will be a time to buy stocks with both hands. But it will be tricky to identify the key turning points, not made easier by the fact that each of the last two years experienced serious downturns right out of the gate, beginning just a few days into January.”

That was just about how it went. The market experienced a mild correction of 7% that began in January and ran into early February. It then recovered to new highs by the end of April, at which time it topped out into a 16% correction to its July low. And as it turned out, that low was a time to buy stocks with both hands. Although the S&P 500 is up only 12% for the year, for anyone who stood aside to await the low, it has gained 24% since the July low, while the Nasdaq has gained 27%.

Unfortunately, the forecast was also correct that it would be tricky to identify the turning point. I got the April top right, with my Seasonal Timing Strategy triggering its exit signal on April 20, just a few trading days before the market’s April 27 peak, and a sell signal in our Market-Timing Strategy in May. But I certainly missed the low in July being the important low for the year, having come to believe during the summer that the low would not take place until September or October.

So now on to 2011:

The economy should continue its slow growth in 2011, inspired by ongoing government stimulus and support, but held back by continuing high unemployment, and a housing industry still mired in a depression, which will keep consumer spending (65% of the economy) muted.

On the stock market, investor sentiment is now at extremes of bullishness and confidence regarding 2011, and for good reason.

Next year will be the third year of this Four-Year Presidential Cycle, and there has not been a negative 3^rd year since 1940. Every administration does whatever it can in the third year of its term to make sure the economy, and therefore the stock market are positive and strong when re-election time rolls around.

And this time around the economy and market will be further supported by the Fed’s additional round of quantitative easing, which began in November and runs through June.

That’s the good news. Next year should be a positive year for the market.

The bad news is that I expect 2011 will be similar to 2010, with considerable volatility and some scary moments on the way to that positive finish.

The problems are liable to begin early in the year. The significant rally from the July low has the market overbought above key moving averages, and has investor sentiment pumped up to extreme levels of bullishness and confidence usually seen at rally tops.

That combination is liable to roll the market over into a correction of some degree beginning in January. By the way, that’s becoming a habit. While historically January tends to be one of the most positive months of the year, in each of the last three years the market has experienced corrections that began in January.  

In all three of those years the correction that began in January bottomed in February or March, and the market then rallied at least into May. And that is my first prediction for 2011.

The market is then liable to run into trouble in its unfavorable season again. The list of potential catalysts for that trouble is fairly long, and includes the ongoing debt crisis sweeping through Europe, which will continue to periodically flare up, China’s increasingly serious efforts to slow its overheated economy and the effect that might have globally, the projected increase in the number of home foreclosures and bank closings even though the economy continues to slowly recover, and so on.

So my forecast is for a year quite similar to this year, with an early correction of some degree, temporary recovery, then a more significant correction, followed by a substantial rally off the low to produce a positive year.   

Sy Harding is president of Asset Management Research Corp, and editor of www.StreetSmartReport.com, and the free market blog, www.streetsmartpost.com.

These reports reflect our opinions and are based on our best judgment, but no warranty is given or implied as to their accuracy. Past performance does not guarantee future performance.

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