My 2011 shopping list

PORTFOLIO POINT: I don’t expect the broad indices to rise during 2011, but some stocks will offer value.

Before I get into the yearly wrap and some gazing into the future, let’s take a quick look at the markets. As I stated last week, while I think that the year-end rally is intact, I would be a little cautious over the festive season as many market indicators are saying that the majority of the market is bullish, which is always a bit of a concern.

While the equity markets didn’t really go anywhere for the week, they didn’t sell off. Equity markets look over-bought, but they continue to work off that scenario by tracking sideways and then extending higher, which has been a common theme over the past several months.

The VIX broke down again on Friday night to the downside. While these levels are concerning, because it is often from here we get sell-offs in risk, right now I would view this as a positive for equities as their new highs are being confirmed by new lows in the VIX.

In 2010 we had a lot to contend with: the threat of a double dip in the US; Europe was covered in volcanic ash and debt threatened to choke it to death; aggression on the Korean peninsula; and, of course, the major overriding theme was Ben Bernanke and his QE2. This ultimately drove commodities and stocks higher; the expression 'Don’t fight the Fed’ was as relevant as ever in 2010.

But was Bernanke a winner in 2010?

In the area of supporting the stockmarket and encouraging a rally in risk assets, he gets a 10 out of 10. Bernanke first flagged additional purchases of longer-term securities in his speech at Jackson Hole.

Since then the S&P 500 has rallied 20% but since QE2 was put into motion in early November Treasury yields have gone up (80 basis points in 10 years) making the cost of borrowing more expensive and, in turn, making it harder for the US housing market to get off the canvas. On this score I would have to give him 5 out of 10.

Ron Paul, the Congressman from Texas who is a champion of sound money and abolition of the Fed, will chair the monetary affairs panel next year as the Republicans take over the House of Representatives. My prediction for 2011: Bernanke is in for a much tougher fight to sell his money printing scheme.

The prices of nearly every commodity. from wheat to copper to coffee to sugar and to oil, are all at one-year or multi-year highs. Oil has risen to one-year highs in a stealth move that not many are talking about. While gold and copper have become sexy, oil is flying underneath the radar.

As the weekly chart of oil shows above, it is currently trying to break through the 50% level from its July 2008 high to its December 2008 low. This is a huge level for oil; I happen to think it will push through these levels, up to the 61.8% retracement level at US$102.

This could be one of the key risks for the US recovery next year. While Bernanke says there is no inflation, try telling that to the US consumer, who is paying more for all the basic commodities and potentially a lot more for fuel.

With unemployment in the US remaining stubbornly high and a recovery that is in its early stages, I see a higher oil price as a risk in 2011.

One of the big positives for a continued recovery in the US is the passing of the tax extensions and unemployment benefits, but it is also one of the key risks at some point in the future. Moody’s credit agency said last week that the new tax cut deal between Obama and the Republicans means US Treasuries may lose their AAA rating within two years.

It says that the cost of funding the tax bill and the unemployment benefits will increase the ratio of government debt to GDP to 72–73%. “This is a very high ratio compared with both history and other highly rated sovereigns,” Moody’s says.

I don’t belief the remedy for countries with excessive debt, is more debt. Ultimately you have to pay the piper.

Considering this is my last note for the year I thought we should look at the winners and losers of 2010 and try and gaze into the future.

The Indian and Russian stockmarkets were big winners, both up more than 14%, while China was the big loser, down 11.7%. US 10-year government yields were down 13%, the VIX was down 25% and the Baltic Dry Index was down 36%. The big winners were gold (up 25%) and copper (up 23%).

Our very own ASX 200 is down 2.21%, with the Australian dollar up 10%.

Our top 20 stocks were pretty much a disaster, apart from Newcrest (up 15%) and Rio Tinto (up 14%). On the negative side of the ledger, QBE (down 28%), AMP (down 20%) Macquarie (down 22%) and Telstra (down 20%). ANZ was the only bank of the four majors to be up for the year.

I think 2011 will be another volatile year and I don’t believe the broader indices will be materially higher than where they are today. But I do believe we will get a chance to buy equities cheaper than where they are currently trading, throughout the course of next year.

There will be plenty of opportunities to make money; I still like agriculture and commodity stocks, although I think you will have to be a bit more nimble in 2011.

I am especially bullish the energy sector for 2011 and I think Woodside Petroleum (down 8% in 2010) is one way to play that game. BHP still needs to do a friendly deal so CEO Marius Kloppers can tick that box. While I like BHP as well, if this deal does eventuate, there will be some short-term pressure on that stock.

With a guaranteed dividend for the next two years and with some uncertainty out of the way regarding the NBN, perhaps Telstra could finally be the dog that has its day in 2011.

While many are tipping the banks to outperform next year, I am not so keen. The housing market is under pressure and I think it will stay that way in 2011; regulation, increased competition and the risk of a credit event that would push up the cost of funds remain threats.

The Australian dollar up near parity is getting overvalued but that’s not to say it can’t go higher. I think the range for next year will be $US1.03 to US90¢. As I pointed out above, I think short-term, bonds may be staging a recovery, but it’s hard to get to bullish on bonds in 2011, particularly in the US.

The key risks next year: higher oil prices hampering the US consumer; China/India putting on the brakes too hard; contagion in Europe leading to another credit event; Ben Bernanke losing control of the bond market and creating higher interest rates, which could prick the commodity bubble; conflict on the Korean peninsula or Iran; and trade wars.

Now, to the positives for 2011: The third year of a presidential term is historically the best one for risk assets such as stocks. Bernanke is the one still driving the bus and he is determined to add as much liquidity as the system needs; he has bailed us out before and he will most likely do it again. The rise of Asia is the real deal and the Obama’s tax extensions are another huge injection and major positive for the world’s biggest economy.

Nothing in markets or life ever goes exactly how you plan, which is what makes it so exciting. I’m sure that 2011 will bring us all a few curved balls; hopefully I can try and spot a few for you. The watershed moment for the markets of 2010 was Ben Bernanke’s speech at Jackson Hole in August.

What will it be next year?

The fact that Liz Hurley spent a few nights with Shane Warne gives us all hope and reminds us that anything can happen and it probably will.

See you in 2011.

Tom Lovell is a strategist with London-based futures broker ICAP.