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Is there much upside left for stocks in 2011?

Posted on 28 November 2010 with no comments from readers

What lies ahead for the US stock markets in 2011? On the one hand economic growth forecasts for next year are none too exciting, and not enough to meaningfully boost housing and jobs. On the other, the market manipulation by the Fed is underpinning the market, though as US home owners know this is no guarantee to riches.

Over the past 20 months the S&P has surged by 70 per per cent. How much has the US economy grown in that period? And how much did that growth cost in terms of additional debt? Is there still a double dip recession risk on the horizon?

Stocks too high again?

The achilles heel might be an overbought stock market itself. If stocks correct to a more reasonable reflection of the value of US business going forward then that would put a dampener on an already weak economic outlook.

Financials could be the leaders in the downturn. You only have to look at the mounting European debt crisis to realize that banks have more bad debts coming their way. Moreover, the troubles in the bond markets of certain European countries look like a taste of what is to come in other big debtor nations down the line.

Higher interest rates might well start to emerge in the New Year as investors around the world become more leery of high debt levels and in view of the truly staggering borrowing requirements in the year ahead. Money will be more in demand than ever and so the price should go up.

Banks are also going to have to take some of the pain in terms of failed businesses and investments very soon. Always in a financial crisis a lifeline is cast to everybody to prevent systemic collapse, but later banks do pull the plug on customers whose position is hopeless. Recoveries can be fatal for some patients.

High yield stocks

Even going for higher yield, basic stocks does not help if interest rates are rising and depressing the capital value of such stocks. Then at least for a short time it is best to be in cash until the deflation of asset values is done, and the purchase of the best stocks at discounted prices can be accomplished.

However, the conundrum for investors is the Fed and its $600 billion QE2 program. Will this flow of money support stock prices while inflation quietly undermines cash and devalues the dollar? That is surely the intention but financial markets have a habit of sudden changes of mood and this prescription seems too widely understood to actually work.

Suddenly staying on the sidelines in cash or cash equivalents has seldom looked more appropriate. It is a pretty boring world if the best thing for investors to do is nothing, and yet that seems to be the case now. After all, the downside risk for holding cash is say a maximum of 10 per cent inflation, while the downside for stocks is 70 per cent compared to an upside of how much?

Even gold and silver look to be approaching, or have actually passed, a short-term peak, so their value as a safe haven my be limited at this juncture.

Posted on 28 November 2010 Categories: Banking & Finance, Bond Markets, Global Economics, US Dollar, US Stocks

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