Ten Things that Will be “More Normal” in 2011
Getting on the right side of trends is important for successful investing. The biggest theme for 2011 is that many things will become “more normal.”
This is not an article about some “new normal” or even the “old normal.” It is not a prediction that problems will disappear. That sort of “light switch thinking” dominates most discussions about stocks and the economy. It is simplistic to say, “We either have a problem, or we do not”. Those who cite the various economic worries, challenge every solution as inadequate, and they are correct. Most problems cannot and will not be solved in a single stroke. Improvement comes gradually.
Here are some ideas around this theme. Each idea represents a variable or relationship that is stretched to an extreme value. These are all things that will become more normal in 2011.
- Profit margins. Profits have grown rapidly through cost-cutting, slow employment growth, and a touch of revenue growth. I join with those who see margins moving closer to normal levels, particularly as revenue increases. This means slower earnings growth, but not a reduction in earnings.
- Temporary versus full-time workers. Employment has lagged the economic recovery. Businesses have been cautious in hiring, showing a preference for temporary workers. The mix will start to change.
- Business investment. Businesses have been cautious, with executives joining in the worry about the economy. There is plenty of cash on corporate balance sheets, and 2011 will see increased investment.
- Bank lending. Banks have been very cautious, rebuilding capital and enjoying the yield curve spread. There are many indications that lending is starting to expand and credit availability increasing.
- Government revenues. Revenues at both the federal and state level have increased, to the surprise of many. This has happened even with the extension of the Bush-era tax cuts and the slow economic recovery.
- Consumer confidence. Measured by any of the surveys, consumer confidence is gradually improving. It is still far from normal levels, so expect it to get “more normal.”
- The market multiple. Stocks have been trading at a low P/E multiple relative to forward earnings. I expect this to improve in 2011. I’ll predict a modest gain of about one point, which would add over 7% to the S&P 500 for the year, in addition to regular earnings growth.
- Relationship between stocks and bonds. Stocks and bonds will move closer to a normal relationship. Right now the world has rushed to bonds despite the poor yield. The asset allocation models of major pension funds will continue to recognize the yield differential.
- Financial stress. The various sources of financial stress will continue to improve. Government solutions in Europe, the U.S., and state government are far from perfect. The situation will not be solved but it will be less imperfect. If you are reading this and you currently find yourself dealing with financial struggles, it may in your best interest to check out sites like DebtConsolidationUSA.com, as this may be the step you need to take in order to get your financial life back on track. This is nothing to be ashamed of, as many of us go through money related issues. Plus, we all need a helping hand once in a while.
My weekly monitoring of the St. Louis Financial Stress Index is intended to take this subject from the world of the anecdote to the analysis of actual data.
- The inverse correlation between stocks and the dollar will break down. This has already started. The long-term relationship is positive, but traders have a short memory. The simplistic “risk on, risk off” will gradually be replaced by opportunities to pick winning stocks and sectors. This point may seem a little wonkish for some, but I believe that it has inhibited the normal stock reaction to earnings for at least eighteen months.
Most of the daily news flow is about market headwinds and lists of worries. There are many. Here is a useful exercise: Take your personal list of major problems. Every few months ask whether things are better or worse. Be objective. Use actual data. I’ll bet you will be surprised at what you learn. It is so easy to fall into a rut of repeating the same litany, especially if it reaffirms your political/economic/market viewpoint.
My list for this article came from notes I keep about traditional relationships that seemed to be at extreme levels. They are all becoming more normal. In general, improvement in these relationships will be a market-friendly development.
Note also that these are not short-term trading indicators, like sentiment. These are more closely tied to market fundamentals. In a few months we can all see how these themes played out.