Three Predictions for 2011

1.  Bonds will continue to get clobbered.  I've written extensively about what's taking place with M2.  Money supply growth will be one of the factors behind the destruction of bond values, but the economic rebound taking place will also add pressure to bonds as investors seek out better investment opportunities.  Yields on the 30-Year Treasury Bond should easily top 5% before year's end.  Unfortunately, many investors will learn that their "flight to safety" wasn't so safe after all.

2.  Stocks will continue to recover, but volatility will increase.  Volatility in the bond market will make itself felt in stocks.  But the trend for growth in corporate profitability remains intact.  And a positive yield curve is extremely helpful for growing corporate profits.  This is a great set-up for the S&P, if you can stomach the roller coaster ride.

In many ways, this year is reminiscent of 1994/1995.  Few remember the bond crash of 1994, but there's a great paper that discusses its aftermath here.

3.  The U.S. dollar will firm up against most currencies.  Unfortunately, this will be bad news for commodities investors, as a stronger dollar will dampen gains for most raw materials.  I might not bet against $100/bbl oil.  The markets for crude are always insane, and the same goes for gold.  But as a whole, expect commodities to post lacklustre returns for 2011.

S&P Raises Forward Earnings Estimates Again

As of December 21st, Standard and Poor's current operating earnings estimates for the S&P 500 across the next four quarters (4th quarter 2010 through 3rd quarter 2011) are now 91.42.  This compares to their previous estimate for the same period, released November 23rd, of 90.99.

As the prospects for more vigorous economic growth in the year ahead improve, I expect to see additional improvements to their earnings estimates.

Despite trading at multi-year highs now, the S&P still remains relatively cheap, at least compared to bonds.  (13.8x forward earnings for an earnings yield of 7 1/4% vs. the 10 Year T-Note yield of 3.35%)  And yet we are beginning to see certain segments of the market where valuations have become unrealistic.  Companies like Netflix and Salesforce.com trade at multiples that are wholly unsupported by their fundamentals.  The "momentum" crowd seems intent upon pushing them to even higher, unsustainable prices.  Still, as an asset class, stocks as a whole should deliver superior risk-adjusted returns for the next year or two.

Current Year-Ahead Earnings Estimates from S&P

As of November 23rd, Standard and Poor's current operating earnings estimates for the S&P 500 across the next four quarters (4th quarter 2010 through 3rd quarter 2011) are 90.99.

For the four quarters, 4th quarter 2009 through 3rd quarter 2010 (with 99% of earnings reported for the last quarter), operating earnings were 78.87.

Expected year-ahead earnings growth:  15.4%

The current operating earnings report showed an increase of 99% from the previous year's operating earnings, but that included the fourth quarter of 2008, where operating earnings were a horrendous -0.09.