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Mark's Market Blog

1-5-11: Mark's Bold Predictions for 2011.

By Mark Lawrence

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After six weeks or so of moving upwards, a market correction is upon us right now. I expect the markets to drop from the current S&P 1270 level to something in the 1220 to 1170 range, a drop of 5% to 8%. The US economy continues to perform well, foreign crises seem contained at this time, and Bernanke continues to throw money out of his helicopter, so this correction will be narrow and shallow.

S&P 500 July 12 2010 to January 4 2011

How did I do on last year's predictions? Here's my predictions for 2010:

  1. The Republicans take control of the house of representatives, winning over 40 seats from democrats. yes, it was 63
  2. Unemployment raises from the current 10% level, and stays above 10% all year long. no, it leveled out in the mid-9s
  3. Several states will have their credit rating reduced to junk or near-junk. no, I was a bit early on this one
  4. There will be inflation in foods and commodities, and deflation in manufactured goods. yes
  5. Housing prices will decline another 5% to 10%. yes
  6. Banks will fail at the rate of about five per week, about 250 in the year. A bit high, we had 170
  7. There will be a major external financial shock, such as Greece or Spain defaulting on their debt. The stock markets will have a major leg down. Not yet. Not in 2011, either.
  8. The first cracks in government retirement programs will appear yes

This year's bold predictions

This is the year states start having their credit ratings reduced, and interest rates go up. There will be talk about a federal bailout, but with republicans controlling the house and the worst states being democratic strongholds (California, Illinois, New York, New Jersey, Michigan) this is a non-starter. In fact, the state's crises will be caused in part by republican termination of the existing state bailout program, "Build America Bonds," where the Feds pay a third of state interest costs. By summertime, there's going to be several states and at least a dozen cities paying interest rates like Greece and Ireland. Many cities already on the edge are going to go over. States can't go bankrupt, so we're going to see assets sold off at garage sale prices - landing fee rights at LAX, SFO, O'Hare, JFK; bridges and highways sold or leased then converted to toll roads; state and municipal buildings going private. Anything to take in some money and delay the inevitable. There will not be a default on any state bonds this year.

States and cities will wrestle with retirement programs. States will help / force a bunch of cities into bankruptcy to let the unions know they're serious. There will be some union concessions, but not enough. State budget cutbacks will start to lay off significant numbers of police and teachers, and free criminals. Voters will start to be outraged, as the debate is framed by governors as "We can't police your neighborhoods or educate your children because we're paying $100,000 per year in retirement benefits to a bunch of people in their early 50s." This problem will not be resolved this year.

House prices will decline another 5% to 10% as more and more foreclosures hit the market. New house construction and sales will remain flat at their current very low level, or perhaps even decline a bit. Banks will remain under pressure from the defaults, and the Fed will have to continue to keep interest rates low to help keep the banks on life support.

Unemployment will continue to hover near 10%, as private businesses do just a bit of hiring, and state and local governments continue to lay off. As long as jobs remain scarce and house prices continue to decline, consumers will remain scared and cautious and the US economic recovery will remain anemic.

Oil prices will hover in the $90 to $110 range for the year, a level that impacts our economy and tends to drive us towards recession. Coupled with something in the neighborhood of 4 million Americans finding they've hit their 99 week unemployment benefits limit, we're going to see economic growth slow starting in the summer.

There will be several European default scares, but the European central bank will manage, barely, to continue to play "kick the can down the road." Finger pointing and tension starts between the bulk of Europe that needs the Euro substantially devalued, and Germany who is doing great. The stock market will nose dive on each scare, and recover a week or three later when it's realized this isn't the big one.

Fannie Mae and Freddie Mac will continue to run up huge losses on their mortgage backed bonds. The total losses will run to $500B or more. What will happen? Nothing. No politician has any incentive to touch this. Eventually you'll hear something about the Fed buying bonds from Fannie and Freddie, then the bonds will languish on the Fed's books for a decade or three.

This year water hits the radar. China has 23% of the world's population, but only 7% of the world's fresh water - and a large fraction of that is the Brahmaputra River, which is shared with India. India has another 22% of the world's population, and again a shortage of fresh water, a shortage made much worse by their habit of using their rivers as sewage dumps. There will be rising tension between China and India as China starts to make noise about diverting the Brahmaputra, just as the Colorado river is now dry when it hits the Mexican border. This tension will eventually lead to a small border conflict, but not this year I think. A nice little border war will help both beleaguered governments divert their population from questions of inflation and food shortages.

China continues to inflate their real estate bubble, scaring everyone. No pop this year. The worst of the bubble is driven by cities and municipalities making crazy investments and effectively forging loan documents. China's central government can simply order that this market not clear. This bubble will not pop until something scares the average Chinese worker. China loves building roads to nowhere, airports that land no planes, cities that house no people. Building such things employs hundreds of thousands. It's also highly inflationary, as construction workers make good money but produce nothing usable. There will be continued cries by western pundits that China is about to implode. Won't happen. China, like Japan 20 years ago, has plenty of money to avert obvious disaster and turn it into a lost decade instead.

Food prices continue to rise in 2011, as more and more Asians join the middle class and can afford more and better food, and as water shortages and wrong-headed policies, like the US burning much of our corn production as a gasoline substitute, cause food production to level out or even drop. Also middle class Asians want more meat and less grain. Beef takes 100 pounds of feed to produce 1 pound of meat. We're going to start to hear about poorer people - Indians, Africans, Filipinos - being priced out of the food market.

Deflation in manufactured goods continues, as various Asian countries fight to maintain their exports into America's declining consumer economy. They need the jobs more than we need the plastic crap, so prices will fall.

China and India will be deep into stagflation. Inflation in both countries will continue to rise, particularly in foods and energy. Employment growth will slow, perhaps stop. These governments will spend a couple years trying a lot of stupid things to control prices, but none will work. Bottom line, to contain inflation they have to stop building empty cities. 20 years ago high inflation helped lead to Tiananmen Square in China; now they have to choose between high inflation or unemployment. Neither is acceptable to the population, but the governments will prove helpless and hapless to control either. Civil unrest will increase this year in both countries.

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