Time for a market breather?

Since the market’s rebound from the choppiness of last summer, the stock market is up about +25%! That’s great news for all of us. However, the question we now hear many of our clients inquiring about is “Where does the market go from here?” As in the case with most financial professionals, we think the answer is up as we believe that 2011 will be a good year for the market. But, we are expecting some consolidation (or pause in the current uptrend) over the next few weeks. The tone of the market has gone from concern last summer to some complacency today. As a result of our expectation for a short-term pullback in the market, we are sitting on all cash that has been recently deposited. Below are a few key reasons for our concerns:

1) Institutional investors are too bullish. A survey by Investor Intelligence of institutional investors currently has the percent bearish at 19% and those that are bullish at 57%. The bullish percentage is at its highest level since October of 2007. The spread of bullish investors over bearish investors (57%-19%= 38%) has only been recently this high in April of last year and October 2007. For us, this is a bearish indicator as the crowd now thinks the stock market is the place to be.

2) Individual investors are bullish as well (but not as bullish) with 52% of the American Association of Individual Investors (AAII) members bullish compared to the historical average of 39%.

3) The Volatility Index (VIX) has fallen dramatically from its May high of 48 to its close of 15.46 this past Friday, which highlights the complacency mentioned previously. The last time the VIX was at these levels was in June of 2007.

4) From a technical aspect, the stock market is overbought with the Relative Strength Index reading currently at 77. A reading above 70 indicates the market may be due for a short term correction and has been at these levels for 3 to 4 weeks.

Importantly, we believe that the long-term trend of an up market is still intact. However, the market’s frothiness needs to be worked off for the market to be able to march forward again. The market will take one of two paths to arrive at that point: 1) The market falls in value, or 2) the market remains in a trading range for a few weeks. With this perspective, we think it makes more sense to be cautious with your cash until the overbought conditions are alleviated.

Sincerely,

Your THOR Team

Our Thoughts on 2011

We want first to wish all of you and your families our very best wishes for the New Year.  Second, as is the case for any new year, many people, clients and non-clients alike, have asked for our opinion on the upcoming year.  Of course, any opinion is just that, an opinion and subject to change based on the economic conditions that lie ahead.

Economy

- We expect the economy will continue to improve in 2011 with unemployment (being a lagging indicator) showing the most improvement later in the year.

- Government spending will come down significantly at the state and local level.  Politicians will not want to voluntarily reduce spending, but they will be forced to because they must balance their budgets.  We believe that this reduced spending will be replaced by private sector spending.

- We believe (maybe we are naïve) that Federal government spending under the new Congress will decline.   Even if spending is not reduced, we don’t see any major expansion in spending by the Federal government.  The perception of the Federal government getting its house in order will improve confidence, thus improving the economy overall.

- Our sleeper prediction is a cut in the corporate tax rate this year.  This will spark investment in the United States from both domestic and foreign companies.

Stock Market

- We believe that the stock market will end 2011 on a positive note.  Short term, we expect a breather in the weeks ahead with the market resuming higher thereafter.  The market may experience some difficulty later in the year.

- Large companies will outperform smaller companies as overseas investors’ confidence in our economy improves.   Overseas investors tend to buy larger well-known companies.

- We believe US stocks will outperform foreign stocks, especially if our prediction of a cut in corporate taxes occurs.

Bonds

-   As the economy improves, we expect interest rates to rise throughout the year.  This will have a negative impact on bonds, especially long-term government bonds.

-    The municipal bond market will get a shock sometime this year as one of the states with huge budget problems comes close to defaulting.  Our first choice is Illinois with California being a close second.  The municipal bond market is thinly traded and any jolts will have a major impact on bond prices.  At that time, we could see ourselves buying high quality municipal bonds that are beaten up and offering great opportunities.

-   Corporate bonds will continue to outperform government bonds as we expect yield spreads to continue to narrow throughout at least the first half of this year.

Other Thoughts

- We expect the dollar to rise this year for two reasons: 1) a better economy in the US, and 2) a near collapse of the Euro.  Politically, we don’t see how Germany can shoulder the weight of the PIIGS on their shoulders.  The German people will not continue to stand for bailing out the weaker countries in the Euro zone.  If corporate tax rates are reduced in the US, money will flow into the US from foreign companies and US companies repatriating cash to dollars.

- Gold will have a tough year.  Gold pays out no interest or dividends and has risen in large part due to fear.  If Congress reduces spending and confidence improves, that fear will subside.  Gold also will have to compete with higher yielding bonds and money market funds later this year.

- 2011 will be a great year for Cincinnati sports as the Reds make it to the World Series and the Bengals win their first playoff game in years.

Please keep in mind that these are just opinions and no investment should be made based on these (especially the one on the Bengals making the playoffs!).  We look forward to a healthy and prosperous year.

Sincerely,

Your THOR Team