The “January effect” has already begun, with the biggest December gain since 1991. The stock market is relentlessly rising on high volume, due in part to portfolio adjustments in late December – soon to be followed by pension funding in January – but there’s a lot more than the predictable calendar cycle at work here. Below, I’ll cite at least 11 reasons to anticipate double-digit gains in the S&P 500 in 2011, but first let’s take a look at how far we’ve come in the second half of 2010:
Since the March 2009 market lows, the gains are even more dramatic, but what we’ve seen since then is just a reversion to the status quo ante-bellum – before the financial world fell apart in mid-September, 2008. Looking forward, 2011 promises more of a “normal” historical recovery:
The Political Cycle Enters its “Sweet Spot”#1: The third year of the Presidential cycle historically delivers more gains than the other three years combined. Here’s a chart of stock market trends during the Presidential cycle:
Going back to 1962, the average gain in the S&P 500 from the mid-term Election Day to the end of the following year is +20.9%. During the first term of a Presidential cycle, the S&P 500 rose an average 23.8% from the mid-term election to the end of the third year. If that pattern holds true this time around, the S&P 500 will close 2011 at a lofty 1478, and the Dow will reach 13,850.
#2: Record-setting Congressional shifts are bullish for stocks: The 2010 election was the most dramatic turnaround in Congress (after a new President’s election) since 1922. The Republicans gained even more seats than they did in the Republican Revolution of 1994, after which the stock market soared for five straight years. This is not a partisan statement. The same five-year surge happened when the Democrats took over Congress in 1954, during a Republican administration; in 1982, when Reagan’s Republicans lost 26 seats; and after the shocker in 1922, when Harding’s GOP lost 77 seats. When voters rebel this dramatically, creating warring forces in Washington, the market responds with more than a good year (1923, 1955, 1983 or 1995), but five great years.
#3: The GDP generally soars in Years 3-4 of a Presidential term: In his December 10 column in The New York Times, that paper’s chief financial correspondent Floyd Norris showed how (and why) the market soars in the third Presidential year: “In the years from 1946 through 2009,” he reported, “62% of the American economy’s growth came during the final two years of presidential terms, compared with 38% in the first two years.” That’s because Presidents “find ways to stimulate the economy and thus spur both growth and share prices.” Norris calculated that “an investor who owned stocks during the third years of terms, and stayed out of the market during the other years, would have earned profits more than twice as great as those that went to an investor following the opposite strategy, owning stocks in all but the third years.”
#4: The extended 2003 tax cuts should boost consumer spending and the economy. The recent tax-cut extension is one recent example of how sitting Presidents will do whatever is necessary to promote their re-election by giving the economy an extra boost going into an election year. (This was also true of the initial tax cuts, in 2003, going into the President’s re-election year campaign.) After the 2003 Bush tax cuts were extended, most Wall Street economists raised their 2011 GDP forecasts by 0.5% to 1.0%. Pimco’s bond-centric economists raised their GDP growth forecast from a range of 2.0%-2.5% up to 3.0%-3.5%, while the most pessimistic economist around, namely Nouriel Roubini, now expects that the U.S. economy will reach 3% growth in 2011.
#5: The Fed’s Quantitative Easing (QE-2) is scheduled to run through at least June 30. Fed Chairman Bernanke said on “60 Minutes” last December 5 that he would do “whatever it takes” to avoid deflation, even launching a round of QE-3 or QE-4 if necessary, to boost the economy. When asked whether this long-term commitment to adding liquidity to the economy could cause a return to inflation, or even runaway inflation, Bernanke said he was “100%” confident the Fed could reverse its accommodative monetary policy when necessary. He “could raise interest rates in 15 minutes,” if needed, he said. In short, the Fed is playing with inflationary fire these days, but the good news is that any threat of deflation or economic contraction will remain very low.
Business Fundamentals Also Point to Higher Stock Prices in 2011
#6: Improving consumer sentiment and spending will boost GDP further in 2011. Last week, the Reuters/University of Michigan consumer sentiment index rose to a six-month high of 74.5. Retail spending rose 5.5% in the 50 days before Christmas, the biggest gain since 2005, according to MasterCard Advisors SpendingPule. Sales of apparel rose 11.2% (vs. -0.4% in 2009), luxury items are up 6.7% (vs. 0.9% last year), and even furniture is up 3.8% (vs. -2.2% last year). If you visited any mall in America during December, you know the consumer is back with a vengeance.
#7: It’s Time to load up on new technology: The late 1990s economic growth surge, and the corresponding tech-stock mania, was fueled by the Internet and other new technologies. Today, a new wave of business and consumer technology is developing on the horizon. Businesses that rely on technology will need to load up on these new products to improve their productivity and competitiveness. New products include cloud computing, faster networks, Voice over Internet Protocol (VoIP) and older online services like Priceline.com to save money on corporate travel. Consumers are also loading up on the latest gadgets to keep up with real-time information needs.
#8-Jobs will return in 2011: The jobless rate is always a lagging indicator. In fact, jobs are one chief source of mid-term election-day anger: After the 1990-91 recession, the jobless rate didn’t peak until mid-2003 (after the 2002 elections). In the 1981-82 recession, the unemployment rate peaked at 11% in 1983, after the 1982 elections. The same trend may have struck again in 2010, but businesses are finally in a hiring mood. Bloomberg recently reported that the unemployment rate dropped in 28 states in November, while The Wall Street Journal reported that Indeed, which runs one of the largest employment websites, said that the number of Internet job postings rose 74.1% to 4.7 million on in early December, compared to 2.7 million a year earlier. We may even see the first signs of a turnaround in jobs during the December payroll report, released January 7.
#9: Corporate fundamentals are better than ever, with strong earnings, rising cash flow, record-high productivity and overflowing cash reserves. Corporate America has accumulated nearly $2 trillion in cash in their company cookie jars, while raising another $20 billion per week ($1 trillion per year) in new bond offerings at low interest rates. While it’s true that earnings momentum may slow during 2011, due to more difficult year-over-year comparisons, the absolute increase in earnings will likely return corporate America to its pre-2008 growth rates in 2011.
#10: Global trade is booming: While the U.S. and Europe grew slowly in 2010, most emerging markets remained in hyper-drive. Economist Ed Yardeni reported that the value of world exports rose to $15.7 trillion (annual rate) at the end of the third quarter. Trade gains in the big G7 nations were particularly encouraging, including the UK (5.9%), Germany (4.8%), France (4.8%), Italy (4.6%), Canada (4.5%), the U.S. (4.1%) and Japan (3.1%). China, the world’s greatest trading powerhouse, enjoyed a record-high $1.7 trillion in two-way trade during November. The rest of Asia followed, with Indonesia’s exports soaring to a new high, followed by notable export gains in Malaysia (10.0%), India (7.9%), and Taiwan (7.8%). Due to rising trade volumes in America, Yardeni estimates that the trade component of GDP could add 1% to 2% to 2011′s overall GDP.
Reason #11: Stocks Will Take Revenge on Bonds: An 11th bullish reason could be the return of the strong dollar vs. the weak euro, due to sovereign debt problems in Europe, but let’s not be too complacent about U.S. debts (state and federal), which rival Europe’s. Instead, let’s look to the ongoing beauty contest between stocks and bonds… Bonds had a great run in 2009-10, even though stocks recovered strongly during each of those years. Bond funds attracted a record $443.9 billion in 2009 vs. just $47.4 billion in equity funds. Then, in the first 10 months of 2010, bond funds did even better, attracting $323 billion, vs. $2.5 billion moving OUT of equity funds. This all changed in November, when the popular tax-free municipal bonds fell on hard times. Investors who thought that high-yield or tax-free bonds were an oasis of safety suddenly discovered that they are not as safe or liquid as they once believed and can lose value as rates rise.
The S&P 500 is up almost 9% since October 8, when the 10-year Treasury bond yield bottomed out for the year at 2.41%. Last week, 10-year Treasury bond rates reached 3.53%. Part of this 112-point rise had to do with the Fed’s QE-2 easing, but with bond prices falling, the rush out of bond funds has now begun, giving the stock market an extra boost going into the coming year.
Those are my 11 bullish reasons to like (and maybe even love) 2011. I’m sure the bears have 11 (or more) reasons why the stock market will go down in 2011, but let’s turn to your views now.
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