Get ready for wild and maybe even exciting time in the stock market as the global economy confronts several critical issues. Economically, in 2011 the slow growth of the U.S. economy, the effects of QE2, China's attempt to rein in its economy, and the ongoing debt crisis in Europe will push the global economy around. The fifth factor will be some unknown event that seems to show up that causes further economic upheaval.
These significant issues will shove the stock market up and down as we experience more volatility than many expect. For reasons described below the markets will struggle for the first half of the year retreating to important support levels. For the second half we could see a nice rally to at least the recent highs and possibly even higher.
This article focuses on the economic drives for 2011. My next one will look at my 2011 forecast for the stock market.
Slump for first 6 months of 2011
First, the effects of the 2008 monetary stimulus from the Federal Reserve and the 2009 Obama stimulus package are ending. While they helped to avert a worse economic plunge, they have not solved the chronic unemployment problem, or the perpetually weak housing sector. Add in the multiyear deleveraging by companies and families; give us the recipe for a slow growth economy that will last for several years despite what any government official can do. As a result, the U.S. economy will continue to experience slow growth in the 2.0% range throughout 2011.
Most of the money from the $800 billion stimulus package was spent before the end of 2010. While a few projects will continue, the money to carry state and local governments is gone. Now these government officials must face reality and cut spending to balance their budgets. This takes billions out of the U.S. GDP as jobs are lost and services cut. Any company dependent on the government will face slowing revenue. Witness what happened to Cisco, as a drop in their government sales hit the company's stock.
Housing in the U.S. will remain weak as the overhang of unsold homes, inventory in waiting (people waiting for better times to sell their homes), and foreclosures provide a ready supply of homes. New home construction will remain constrained, limiting an important part of the economy.
Developing economies will apply brakes to their economy to slow the movement of hot money into their economies from the Fed's second quantitative easing (QE2). China has announced it will raise the reserve requirements for banks, and it is adding price controls on food with subsidies for the poorest Chinese. The problem with price controls is it does not actually stop inflation and it fuels the black market that is already alive and thriving in China. This means inflation in China will remain a growing problem that will force another initiative by Chinese officials to restrain their economy. Such a move will negatively affect any economy that depends on China for growth.
The Irish debt crisis is another hole in the European Union. The decision by the Irish government to nationalize the bad debts of the country's banks, precipitated the current crisis. Now the European Central Bank must step in to bail out the Irish banks and the Irish government. The agreement they put together will call for additional austerity measures that further slow Irish economic growth. By itself, a slower growing Ireland would not have much effect on the U.S. nor on Europe. The problem is this is just a sign of what might happen should other weak European economies find they cannot pay their debts. Think Portugal, Spain, Italy, and some of the newer members of the EU. We should expect at least one of those countries to show up in the headlines as their debt struggles become a crisis.
As some point, the solution to the Greek crisis in the spring of 2010 will not deliver on the budget deficit goals. Look for the Greek budget crisis to show up again.
The European Union has a long way to go to correct he imbalances between the strong economies and the weak ones. At some point, a real debt restructuring will have to occur, possibly in 2012 or 2013. In the meantime, the world will witness a new crisis in Europe every few months causing the world markets to react negatively.
The global economy will swing from one shock to a proposed solution to another shock throughout the year causing greater volatility in global economies and in stock markets.
The stock market will react negatively and pull back to important support levels as it consolidates recent gains and absorbs the new economy.
By the way, inflation in the United States will remain low as unemployment and growth constrain price increases in other than commodities.
Market Rally in the Second Half
The flow of money from QE2 will end in June 2011 if not sooner. When it does, developing countries will not have to fight the inflow of hot money looking for higher returns.
Less new money in the global economic system means lower inflation pressures on these same countries, removing one impediment on economic growth in the second half of 2011. This single event will encourage renewed economic growth. Add in some effort to restrain government spending (not enough to make much difference) and we will have a recipe for the U.S. GDP to remain in the 2.0 to 2.5% level. Not enough to solve the unemployment problem, but better than it has been.
The global economies will still wrestle with the Chinese government officials struggling to restrain their overheated economy. Europe will provide their crisis of the quarter to keep investors optimism in check.
As investors become accustom to these periodic events they will look to the future with an expectation that there is some hope that growth will continue. As a result, the stock market will remain volatile in the second half of 2011, though it will trend up and test the highs of 2010.
The Bottom Line
While we will be in a new year, not much will change. The economic problems that were with us in 2010 remain. The stock market will be as volatile as it has been, if not more so.
Each drop in the market will offer buying opportunities and each rise to a high should be sold to capture profits. This will remain a sector and stock picker's stock market. Good money can be made with careful analysis and stay true to your money management discipline.
