“Our expected gains for the equity markets for 2011 are not much different from what we expected for 2010,” he said. “What’s different for 2011 is that market risk will be more to the upside than was the case in 2010.”
The possible upside factors include an acceleration in jobs gains, a surprise in real GDP, earnings exceeding expectations as occurred in 2010, and Washington D.C. beginning to address the nation’s fundamental debt and budget problems.
On the other hand, Doll’s “what can go wrong?” list includes the possibility of credit problems resurfacing (including US housing, sovereign nations, and state and local governments), commodities price increases causing profit margin pressure, inflation fears, a greater than expected rise in interest rates, undue emerging markets tightening to curb asset bubbles, and currency and capital flow concerns leading to protectionist trade wars.
Additionally, Doll indicated that the magnitude of the market return since the August 2010 lows (US stocks rose over 20% from mid August through the end of the year) means equity markets may have come too far, too quickly. “I do have a concern that the exceptionally strong returns we have seen over the last couple of months may mean that we ‘borrowed’ some of 2011’s returns in late 2010,” Doll said.
“The upside possibilities could lead to stock market appreciation of 10% to 20% more than we expect,” Doll said. “The downside issues could result in low double-digit percentage loss.”
US Real GDP Hits All Time High in 2011
Doll has been publishing his annual “10 Predictions” for the year ahead in the financial markets and the economy for over a decade.
In 2011 the ongoing cyclical recovery will continue, Doll believes, but economic growth will continue to proceed at a less-than-normal pace due to the structural problems that continue to face most of the developed world.
In the United States, although the recovery remains subpar, real GDP will move to new all time highs sometime during 2011’s first half, Doll said. “Real final sales will increase from around 2% to almost 4% as the impact of the government stimulus program and inventory restocking wanes,” he said. “The good news is that this kind of growth is more sustainable and therefore ‘higher quality.’
“Hitting a new high for real GDP also means, of course, that the economy will have moved into a truly expansionary mode,” he said.
In this environment, the Federal Reserve is unlikely to increase interest rates in 2011. “Assuming our growth outlook is correct, the Fed is likely to keep rates at near-zero through the year, although we think it’s possible that by the end of 2011 the futures curve may begin to price an increase into the markets,” Doll said.
Unemployment Dips to 9 Percent
Job growth also will improve as 2011 progresses, with unemployment falling to around 9% from the current 9.8% rate. “We believe the removal of the Bush tax cut uncertainties and the fears of a double dip recession as well as improved confidence will lead to more hiring,” Doll said.
The likely employment trend in 2011 is historically associated with solid market performance, Doll said. “Compared with any other time, equity market returns have been most ebullient when unemployment rates have been high and falling,” he said.
Stock On Pace to Outperform Bonds, Cash
As they did in 2010, stocks will outperform both bonds and cash in 2011, Doll said.
“Stocks pulled ahead of bonds in 2010’s fourth quarter, and we expect that trend to continue in 2011,” he said. “Interest rate risk will be to the upside, given accelerating economic and job growth, the revival of business capital investment, the likelihood that bonds inflows will slow, and fading deflation fears.”
Because the recovery remains “sub par,” the Federal Reserve will likely remain accommodative, which will probably result in some further steepening of the yield curve, Doll believes. Equities are likely to take over from fixed income as the preferred asset class, both in terms of price appreciation and investor flows.
US Markets Set to Continue Their Dominance
In an outcome that surprised many, the United States was one of the world’s strongest markets, and US stocks outperformed the MSCI World Index in 2010—a trend Doll expects will be maintained in the new year. “Strong balance sheets and free cash flow income statements will likely lead to significant increases in dividends, share buybacks, merger and acquisition activity, and business reinvestment,” he said. “Companies delivering earnings with solid growth prospects will likely lead the way, as high intra-stock market correlations continue to fall.”
At the same time, differences between developed and emerging markets will be less pronounced in 2011 than before, Doll believes. “The gap between higher growth rates in the developing world and the lower ones of the developed world will likely shrink somewhat in 2011, causing continued less differentiation in equity returns.”
Predictions for 2011
Here are Doll’s predictions for 2011.
1. US growth accelerates as US Real GDP reaches a new all time high.
2. The US economy creates two to three million jobs in 2011 as unemployment falls to 9%.
3. US stocks experience a third year of double-digit percentage returns for the first time in over a decade as earnings reach a new all time high.
4. Stocks outperform bonds and cash.
5. The US stock market outperforms the MSCI World Index.
6. The US, Germany and Brazil outperform Japan, Spain and China.
7. Commodities and emerging market currencies outperform a basket of the dollar, euro and yen.
8. Strong balance sheets and free cash flow lead to significant increases in dividends, share buybacks, mergers & acquisitions and business reinvestment.
9. Investor flows move from bond funds to equity funds.
10. The 2012 Presidential campaign sees a plethora of Republican candidates while President Obama continues to move to the center.
The 2010 Scorecard
In 2010, risk assets continued the choppy advance they began in 2009. “The S&P 500 ended the year up a double-digit percentage and close to our 1,250 target, as US stocks outpaced most developed markets and many important emerging markets,” Doll said.
Real GDP growth continued in a positive direction but remained subpar compared with most recoveries. In the United States, jobs growth was not strong enough to reduce the unemployment rate. Inflation remained a non-issue in the developed world but began to rear its ugly head in some emerging economies. Government deficit spending and debt levels continued to haunt investors but corporate financial health remained remarkably strong both in balance sheet and income statement terms. “Corporations produced fantastic earnings gains despite mediocre economic growth,” Doll noted.
“To sum it up, although we missed on a couple of the predictions made one year ago, most did come to pass,” he said.
1. The US economy grows above 3% in 2010 and outpaces the G-7.
Score = Correct
2. Job growth in the United States turns positive early in 2010, but the unemployment rate remains stubbornly high.
Score = Correct
3. Earnings rise significantly despite mediocre economic growth.
Score = Correct
4. Inflation remains a non-issue in the developed world.
Score = Correct
5. Interest rates rise at all points on the Treasury curve, including fed funds.
Score = Incorrect
6. US stocks outperform cash and Treasuries, and most developed markets.
Score = Correct
7. Emerging markets outperform as emerging economies grow significantly faster than developed regions.
Score = Correct
8. Healthcare, information technology and telecommunications outperform financials, utilities and materials.
Score = Incorrect
9. Strong free cash flow and slow growth lead to an increase in M&A activity.
Score = Correct
10. Republicans make noticeable gains in the House and Senate, but Democrats remain firmly in control of Congress.
Score = Half-correct
Final 2010 Scorecard:
Correct: 7
Half-Correct: 1
Incorrect: 2
Total: 7.5/10
