All Good Economic News, So Why Am I Bearish for 2011?
~ by Michael Lombardi, MBA

Jobless claims in the U.S. declined to 407,000 last week, according to the Labor Department, the lowest level since July 2008. My take: The economy is clearly improving. If the jobless claims are falling, then the unemployment rate for November 2010 will fall. (President Obama and Fed Chairman Bernanke will be happy people when those November unemployment numbers come out!)

Consumer spending in the U.S. rose in October for a fifth consecutive month according to the Commerce Department. My opinion: I’ve been telling my readers to get into retail stocks. Now you see why. The chart of the Dow Jones U.S. Retail Index led the rise in consumer spending.

Also from the Commerce Department, wages had their biggest monthly gain in October since May of this year. The U.S. personal savings rate rose in October to 5.7% from 5.6%. Consumers are making marginally more money, retail sales are rising and consumers are saving more; a great three-way combination. During the real estate boom that ended in 2006, the savings rate of Americans was negative.

So, with all the good economic news continuing to flow down the pipeline, why am I bearish going into 2011? More specifically, why do I keep calling the market action since March 2009 a bear market rally, as opposed to a new bull market?

The stock market is a leading indictor. With stocks rising so aggressively in 2009, the market foresaw the positive economic and corporate news of 2010. So, what happened in 2010, with the economy getting better and corporate America returning to profitability, was no big surprise.

But going into 2011, I believe the stock market smells a rat. And that rat is higher interest rates. Quietly, almost undetected, interest rates are rising. The yield on three-month U.S. T-bills is literally up 30% in a matter of weeks. The yield on the bellwether five-year U.S. T-bill is rising steadily. Mortgage rates are rising, too.

The stock market doesn’t like rising interest rates. And that’s what I’m concerned about going into 2011. Though it is not polite to say, as a country, we need to thank the European countries like Greece, Ireland, Portugal and Spain for their fiscal mismanagement.

If it were not for the euro being under so much downward pressure, our greenback would be in a free-fall, which would result in interest rates in the U.S. rising even faster than they are presently rising.

Hence, going into 2011, my biggest concern, and what I believe will be the biggest surprise for investors, are higher interest rates…which are a big negative for the stock market. And that’s why we are still in a bear market rally in my opinion.

The next time you read the popular Internet financial sites or the business newspapers and see that the stock market is down because of the problems in Europe with Ireland, remember the facts:

According to the World Bank, the combined Gross Domestic Product (GDP) of Greece and Ireland for 2009 was $556 billion. The GDP of the United States in 2009 was $14.256 trillion. Ireland’s debt woes have very little impact on the U.S. But I’m sure the profits the bond traders have made shorting Irish bonds have been quite spectacular.

Thanksgiving weekend 2010 is behind us. Black Friday is behind us. Back to work. Wall Street opens this morning with a stock market that wants to go higher. I’m looking for the bear market rally in stocks that started in March 2009 to continue moving up through to the end of 2010.

Enjoy the rally in stock prices while it lasts!

“The Dow Jones Industrial Average, the S&P 500 and the other major stock market indices finished yesterday with the best two-day showing since 2002. I’m looking at the market rally of the past two days as a classic stock market bear trap. As the economy gets closer to contraction, 2008 will likely be a most challenging economic year for Americans.” Michael Lombardi in PROFIT CONFIDENTIAL, November 29, 2007. The Dow Jones Industrial peaked at 14,279 in October 2007. A “sucker’s” rally developed in November 2007, which Michael quickly classified as bear trap for his readers. By mid November 2008, the Dow Jones Industrial Average was at 8,726.

I want to stay on the topic of large-caps for a while. Owning solid, dividend-paying stocks in the age of austerity is going to be a decent strategy, unless interest rates skyrocket and cash begins to pay more than stocks (always a possibility down the road, but not anytime soon). I’d like to see more gold producers pay more in dividends to stockholders. They already have so much cash on their books.

There have been some major wealth-creating large-cap stocks this year…and the kicker is they also pay increasing dividends to shareholders. Consider ConocoPhillips (NYSE/COP), which is the third largest energy company in the United States. With over $150 billion in assets and with operations all over the world, this large-cap stock is up about 25% on the market in just the last six months. The kicker with ConocoPhillips is that the stock’s also been yielding between three percent and four percent in dividends. That’s a fantastic rate of return from such a large company in a short period of time.

Also as impressive is the wealth-creating performance of McDonald’s Corporation (NYSE/MCD), which is the kind of mature company you wouldn’t think would be doing so well. This $84.0-billion gem is up around 27% since the beginning of the year, while also paying a solid three-percent dividend. The world’s biggest burger flipper is on track to grow its earning about 15% this year and an estimated 10% next year. This earnings growth excludes the dividend payments to stockholders.

Perhaps the most impressive performance from a Dow stock has been E.I. du Pont de Nemours (NYSE/DD), better known as DuPont, which is making money hand over fist in Asia. This $43.0-billion powerhouse is trading right around its 52-week high of $47.00 a share, having generated an inspiring 38% return since the beginning of the year. While the company’s revenues grew a solid 17% in the third quarter, emerging market sales grew 22% over last year. All this, while also delivering a dividend yield of between 3.5% and four percent all year. That’s an amazing performance for any large-cap stock.

As we know, not all large-caps are doing well in this market. About half the stocks in the Dow Jones Industrial Average aren’t doing much (but they are paying their dividends). Still, stocks like these illustrate that you don’t necessarily have to scour the entire stock market to find a hidden gem. When the timing is right, the biggest stock market stars can be right under your nose.

Big hedge funds buy and sell a lot of large-cap stocks, more so than small-caps. The deal there is that these funds have so much money to trade that they need the liquidity that large-caps offer. I don’t see any reason why an equity portfolio can’t mix it up and have a selection of companies both large and small. With a stable, global company like DuPont generating a rate of return of almost 40% plus dividends in one year, speculating in Chinese shares seems almost not worth it.

The majority of the news is on Ireland and the fear that the debt issues there could spread throughout Europe and further dampen growth there.

But I have talked enough about Europe and will swing my focus to China—my favorite growth region for growth investors looking to increase portfolio returns.

The numbers don’t lie.

The Organization for Economic Cooperation and Development (OECD) predicts that China will grow its economy by 9.7% in 2011 and 2012, which, while lower than the previous rates, is well above the global average of 4.2% and 4.6% in 2011 and 2012, respectively. In the third quarter, China’s GDP increased 9.6% on higher inflation.

Given the high inflation of 4.4% in October, which is above the country’s top limit of 3.0%, China wants to slow down its growth to between 8.0% and 9.0% over the next five years and focus on quality, according to South China Morning Post.

The country’s foreign direct investment (FDI) surged 7.9% in October to $7.66 billion, according to the South China Morning Post. FDI in the first 10 months of the year amounted to $82.0 billion, up 15.7% versus the same period in 2009.

In my view, the key in China will continue to be dependent on the rapid growth of the country’s middle class. In a recent research finding, Credit Suisse predicted that the household wealth in China will double to $35.0 trillion by around 2015, based on achieving sustainable GDP growth at or near the current levels.

There are many areas of growth in China; whether we’re talking commodities, industrial, auto, technology, travel, or education, the list is broad.

Take a look at China’s cell phone sector, with over 770 million users. That’s nearly more than the population of the United States, the European Union, and Canada combined!

These are exciting times for China’s telecommunications market, as the regulators, in an effort to increase competitive powers, decided to allow the operation of three major carriers in China as of September 2008. The introduction of the next generation 3G and 4G networks will also help to drive additional growth in China’s cell phone market, as there will be a need for new phones. China will spend $40.0 billion over the next two years on its new third-generational (3G) mobile communications networks, according to the Ministry of Industry and Information Technology.

The top mobile company in China is China Mobile Limited (NYSE/CHL). With market capitalization in excess of $200 billion, the company is massive. For instance by comparison, AT&T Inc. (NYSE/T) is the largest mobile provider in the U.S., with market cap of $166 billion. Verizon Communications Inc. (NYSE/VZ) has market cap of $92.0 billion.

Chinese stocks listed on both U.S. exchanges and across the Pacific in China are again under some selling pressure, after the benchmark Shanghai Composite Index (SCI) failed to hold above the key 3,000 level. At one point, the SCI was down only about four percent for the year, but it has since retrenched back to a 12% loss.

The volatility in Chinese stocks and the uncertainties with the Chinese government make it nerve-wracking, yet I continue to be bullish on China and take opportunities to buy and accumulate on dips in Chinese stocks. Longer-term, you will not be disappointed.

Volatility abounds and it is coming from every which direction. The Eurozone’s fiscal problems unfortunately persist. Inflation has become a real threat in China and other emerging markets. The U.S. Federal Reserve’s second round of quantitative easing is controversial and, as such, has only dialed the knob on volatility up.

The Fed has decided to release another $600 billion into the U.S. financial systems in an effort to boost the stalled recovery. It will do so by buying longer-term Treasuries. Even when the speculation around the move that started in August, dubbed QE2, has created much controversy both domestically and internationally.

When the QE2 rumors became fact, the Fed and its chairman Ben Bernanke came under fire, forcing them to fight back and publically defend their decision, which is certainly something you don’t see every day. Now economists, traders and investors are waiting for the minutes from the Fed’s November 3 meeting, which is widely expected to offer clues on whether QE3 or QE4 or QE5 may also be in the cards.

Aside from the Fed’s policies, discouraging economic data are also weighing heavily on the stock markets. While U.S. incomes and spending are expected to move slightly upward, the weekly jobless report is expected to disappoint, as the unemployment rate remains obstinately high, close to 10%.

Then there is the Eurozone’s sovereign debt saga and the news that Ireland was not talking about weather with the EU officials after all. They were talking about the bailout package. While the deal for Ireland is still being worked on, all eyes are already on Portugal and Spain. Europe’s seemingly undefeatable mountain of debt is adding even greater volatility for most asset classes, but equities in particular.

Further worrying equity investors and traders are U.S. municipal bonds. The number of municipalities seeking state permissions to file for bankruptcy is increasing. For the time being, states seem to be denying such requests and offering alternative refinancing arrangements. Regardless, a trend is emerging that points towards severe weakness in this market segment. To illustrate, Moody’s bond rating agency has downgraded the cities of San Francisco and Philadelphia, which, in turn, sent municipal bond prices down and yields through the roof.

Perhaps municipal bond yields are a sign of a similar systemic problem the Eurozone is facing, and perhaps they are not. But, if the fear of default on government debt takes flight in North America, regional stock markets could end up in a world of hurt.

To say that the last few years have been volatile for stock markets around the world would be quite an understatement. In just a matter of months, stock markets have been seen creating and annihilating 20% or more of their value in fell swoops. Such rollercoaster rides have left many ordinary investors bruised, battered, and disenchanted with equities.

Unfortunately, there are no easy markets and there have never been any guarantees when it came to investing in stocks. My usual answer would be to focus on commodities, particularly gold, but even this area is a minefield that needs to be carefully navigated. At this point, I don’t see many viable solutions other than diversification, perhaps, across asset classes, geographic regions and world economies.