Looking Ahead to 2011
After successfully avoiding a double dip recession in 2010, the U.S. and much of the global economy is still working through a credit contraction that is likely to take several more years to complete. Personal and public debt is at unsustainable levels and until they fall the economy is at risk of another severe downturn. Other developed countries, primarily in Europe but also Japan, are also suffering from huge structural imbalances. Monetary and fiscal policies appear to have propped up markets but little has been accomplished in terms of reform. Some austerity is being approached in Europe but carries with it the potential to curb much needed growth. The U.S. has avoided budget cuts and entitlement reform to date but is likely to start facing more dire projections that could force our politicians to tackle the tough issues before them.
The business cycle has expanded which has helped corporate profits recover and drive stock prices higher. Assuming we don't have any surprise events, it appears the momentum from 2010 can carry stocks higher as we enter 2011. There are plenty of possible surprises, however.
Inflation appears off the table for the time being. Interest rates did rise from extremely low levels at the end of 2010, the likelihood of a significant move higher in a credit contraction economy is low. The wildcard here is the municipal market where some analysts are expecting tens of billions in defaults in 2011, some even more. Not unlike the debt of Greece and Portugal, an increase in municipal defaults would send their yields up relative to treasuries.
Beyond global debt issues, pay close attention to China. They face a different set of challenges that if handled poorly could cause their markets to weaken which could be a drag on global markets. Specifically, their lending practices are thought to have been lax with billions in non-producing assets resulting from the current boom. Real estate in some markets is thought to be inflated and inflation in general may be causing discomfort for the average citizen. The Chinese have much greater control of their economy but it remains to be seen if they can come up with a recipe that on one hand will cool growth just enough to keep inflation in check, while at the same time grow enough to bring hundreds of millions of people out of a meager standard of living.
Global growth strategies managed by Dightman Capital are slightly under-allocated compared to how they would be invested if the global economy carried less risk. This has caused our strategies to underperform in near-term time periods but significantly outperform since inception. Our ability to move defensively ahead of the market decline in late 2008 turned out to be a very valuable. The extremely high number of potential risk in the global economy along with the general nature of a credit contraction enviromentment has caused us to be somewhat risk adverse overall but has not prevented us from capturing a significant portion of the recovery in 2009 and 2010. The U.S. economy is the most resilient the world has ever known and it proved it again over the last couple of years.
The global debt problem is not going to be fixed overnight. A combination of growth policies and austerity measures are most likely the best chance we have of avoiding a repeat of 2008. Let's hope officials implement the right mix of policies and programs.