Goodbye 2010, Hello 2011!

I have been reading lots of forecasts about 2011 – some in the local South African Sunday papers just say that the emerging economies are the place to put your money, and others, such as the Economist warn that the emerging economies will become more risky as some of them become dangerously overheated and recommend reconsidering the US given the new stimulus from the Tax bill recently passed through the US Congress. The general consensus in terms of investment in stocks is that emerging markets will continue to be the preferred location for stocks, but if US economic policy signals a change towards greater growth in the developed world then this will trigger large capital flows from emerging to developed markets.


In this posting I want to review 2010 in terms of the financial markets and consider the various (geographic) alternatives for a good portfolio strategy for 2011. From an economics perspective, economic growth refers to growth in the size of the economy which should therefore increase the profits of companies in dollar terms as quantities of goods produced increase. Stockmarket prices should be an indication of future profits, so one might expect stock prices and economic growth to be correlated, but interestingly their correlation is not that high. Nevertheless this is more likely due to a variable lag relationship between the two which would not show up in a simple correlation. Common sense tells us that there must be some kind of relationship there, otherwise it would imply complete irrationality on the part of the markets.

There is general consensus now that the US economy is now beginning to recover from the economic downturn, as are the European and Japanese economies. Obviously the continuing US economic recovery is key to a general global recovery given that the US tends to drive global economic growth and therefore the stockmarkets, but there are other considerations for 2011. As of December 15th US economic growth was forecast to be 2.8% for 2010 with stockmarket appreciation of 10%. Growth is likely to accelerate next year, so stockmarket gains should continue into next year, but probably not at an accelerating pace.

The big question marks in terms of where to put your money are Japan and Europe. I do not agree with the cynics on continental Europe and the future of the euro, but stockmarkets are probably not the best place gamble when probabilities are uncertain, as sometimes markets themselves can precipitate crises. In the UK the prospect of cuts and political uncertainties do not make both Southern and middle Europe an attractive proposition in 2011, but northern Europe and in particular the Nordic countries still look very attractive going into 2011, with Sweden the leader of the pack in 2010 ( - growth of 4.6% and stockmarket appreciation of 27%).

Japan, I believe, might be the big surprise of 2011. Japan is still in the throws of deflation with current year over year inflation running at around -2.5%, but growth is now picking up, with the Japanese economy growing at a projected 3.2% in 2010, far ahead of most of Europe, and prices are actually now rising on a month to month basis. Japanese stockmarkets have advanced around 8.3% this year, ahead of all European stockmarkets with the exception of Germany’s DAX index. If this trend continues then Japan may outperform most of Europe, and with a resumption of healthy growth, the Japanese stockmarket could incorporate a sharp upward correction in 2011.

Now to the emerging markets. Although China has been a hot market in 2010 with estimated 10.2% economic growth and its stockmarket up by nearly 22% in dollar terms, I believe that China is now a risky prospect for 2011, with possible strikes, an unfortunate (lack of a coherent) foreign policy, and a rapidly increasing inflation rate. We do not really know what the economic growth rate in China is, as state factories always have an incentive to meet or surpass their targets, so in fact growth may not be as fast as reported. The main point is that a continuing “cultural clash” between the communist run political state and a free market economy could quite possibly lead to greater unrest, human strife and uncertainty in 2011.

Apart from the other smaller South East Asian economies (like Thailand, Malaysia and Indonesia – countries that all experienced double digit stockmarket gains and) which all grew at phenomenal rates in 2010, India with an 8.8% growth rate and a 15.3% (in dollar terms) stockmarket rise, is, in my opinion, a much better long term bet than China. Larger Indian companies are now making their mark in many other emerging markets ( - I’ve seen a surprising number of Tata vehicles on the road in South Africa, for example), and their emphasis on technology and software development all bodes well for the future.

What about the rest of the world? South America continues to surprise, with Argentina, Chile and Columbia leading the pack, and here I would say Brazil is likely the country to watch, as their stockmarket has really not gained this year partly because of fears of overheating, but clearly there is still a lot of potential here. Africa, Eastern Europe and Russia are the wild cards. Africa probably has the greatest growth potential but political instability (as so vividly shown in the Ivory Coast and soon to be seen again in Zimbabwe) is the big problem here. Eastern Europe and Russia also have a lot of potential, but once again politics also plays a big hand, although some countries in Eastern Europe, particularly those that sank fastest and most dramatically in the economic downturn (the Baltic states), are likely to be good places to invest in 2011.

Last, the commodity and bond markets. The commodity markets (and particularly gold) make me nervous right now. There is no real reason for gold to be at the level it is ( - and incidentally that is a good reason not to put money into Australian or South African mining stocks right now), and the fundamentals really do not support further increases in the price of crude oil either. In terms of the bond markets, stay away from developed economy markets as the timing of when interest rates will start to rise are very uncertain, but emerging market bond markets likely will continue to offer good yields, particularly at the long end.