The S&P 500 is currently expected to earn about $92 per share in 2011, up from $82 in 2010. That is growth of just over 12%. However, throughout 2010, companies were far more likely to exceed estimates than fall short of them. The ratio was better than 4 to 1 in each of the four quarters.
S&P 500 Prediction
Since the end of the third quarter, more analysts have been raising estimates than cutting them. I would thus expect that when all is said and done, earnings for the S&P 500 will be higher than $92 per share, most likely in the $95 area. Barring big positive surprises in the fourth quarter earnings, that would put the growth at closer to 16%.
That sort of growth should allow the current P/E multiple of about 15, based on 2010 earnings being maintained. A 15 multiple on $95 earnings gives you a year-end target for the S&P 500 of 1425. To be conservative, and to allow for just a little bit of multiple compression due to rising interest rates, put me down for a year-end level of 1400.
Presidential Cycle: Historic Positive
The third year of a presidential cycle is almost always the strongest of the four. And rarely is it a down year. Historically, the political combination of a Democrat in the White House and a GOP controlled Congress has been the best of the four possible combinations. In 2011, there will be partial GOP control of Congress. Thus the political stars are aligned for a decent year in 2011 as well.
International Markets
The world economy should be pretty strong in 2011. Asia will continue to grow, although China may slow to growth of 8% from over 10% as it tries to control inflation there. India, though, should continue to grow at close to double digits, and what used to be referred to as the Asian Tigers (Indonesia, Thailand, Malaysia, etc.) should have strong years as well.
Natural Resources
One indicator pointing to very strong worldwide growth is the price of copper, which is at near record highs of $4.44. Copper has long been known as the world’s smartest metal, and you ignore its forecasts at your peril.
Oil prices will end the year higher than the current $92, but not dramatically so. If oil prices were to rise to the 2008 highs it would choke off that worldwide economic growth. I would look for a year-end oil price of around $105.
Natural gas is far more abundant here in the U.S., but that should cause more of it to be used, and on an energy equivalent basis, it is extremely cheap relative to oil. Policies aimed at switching to natural gas as a transportation fuel would help on a huge number of fronts, and I think will happen, but I’m not sure how much progress will be made in 2011.
Still I would expect a year-end 2011 price for natural gas of more than $5, possibly as high as $6, but would be surprised if it ended the year higher than that given the ample domestic supplies. Put me down for a year-end price of $5.25.
Tax Policy in the New Year
The recent tax compromise avoids a fiscal contraction in 2011, and the payroll tax holiday makes it a net stimulus (the other key features — extending all of the Bush tax cuts and unemployment insurance — were a continuation of the status quo). While the compromise does mean that the budget deficit will be bigger in 2011 than it would have been, that is OK while the economy is still digging its way out of a massive hole. Over the medium term, however, it is imperitive that we get it under control.
Budget Deficit
Spending cuts alone will not do the trick, particularly if Social Security, Medicare, Defense and the interest on the Federal Debt are exempt from being cut. There simply is not that much spending elsewhere in the budget relative to the size of the deficit. A pickup in the economy will help increase revenues and bring down the deficit a bit in 2011, but net/net look for the Federal Deficit to be larger than it was in fiscal 2010, probably in the neighborhood of $1.4 trillion.
Employment Expectations
It looks like we are finally getting some traction on the employment front. Last week’s decline in initial jobless claims to 388,000 was very good news. However, the numbers can be a bit flakey around the holidays, so let’s wait a few weeks to see if the good news sticks.
Job creation should pick up in the new year. In the first 11 months of 2010, we averaged 87,000 jobs a month. That should almost double in 2011, to around 170,000 net new jobs per month — almost all on the private sector side. That would mean just over 2 million jobs created in 2011. That’s good news, but we lost over 8 million in the economic downturn, and the population continues to grow.
The labor force participation rate has also been falling over the last three years. As the economy starts to improve more visibly, that is more likely to reverse that continue. The end result will be a very slow decline in the unemployment rate. We need economic growth of at least 2.0% just to keep the unemployment rate from rising due to both population growth and higher productivity. A good rule of thumb is that each 1% of real GDP growth above that produces a 0.5% decline in the unemployment rate.
U.S. real GDP growth is likely to be around 3.5% in 2011, and a net of 2 million jobs added would be consistent with that sort of growth. The end result is that by the end of 2011, the unemployment rate should still be above 9%, but not by a lot, and will be clearly better than the 9.8% level of November. Put me down for 9.1% at the end of the year.
Inflation Concerns
Inflation, particularly at the core CPI level, has not been a problem of late (unless you count the possibility of deflation to be a problem — it is, but it’s the opposite of what people generally think of for inflation being a problem.) I expect that inflation will continue to be well behaved, in large part because of housing prices.
The direction of rent and owners-equivalent rent impacts the CPI far more than the direction of oil prices, and that is obviously even more true of core inflation. The Fed’s QE2 program probably takes the threat of outright deflation off the table, and it should help support the 3.5% of better real growth. I doubt it will spark serious inflation, though.
Core inflation should be between 1.0% and 2.0% for 2011. If my oil price prognostication of $105 proves correct, it implies that headline inflation will be higher than core inflation, most likely between 2.0% and 2.5%. That is still higher than what we saw in 2009 or 2010.
Bond Rates
Even though long-term bond yields have moved up dramatically in recent weeks, they are still extremely low. At 3.36%, the 10-year note does not offer a very compelling return if inflation is over 2% and moving upwards. It is likely to end the year over 4%, but I don’t think it starts to soar back to double digits or anything like that. It should end the year between 4.0% and 4.5%.
Mortgage Rates
The 30-year fixed mortgage rate should rise along with the rate on the 10 year, and will probably stay about 100 basis points above it, so the year end mortgage rate should be between 5.0% and 5.50%. Since there will still be significant economic slack, I doubt that the Fed will start to tighten monetary policy in 2011, so the Fed Funds rate should be right where it is today at the end of the year at a 0% to 0.25% range.
Housing Prices
We still have a massive overhang of housing inventory, especially of existing homes, with 9.5 months of supply based on the December sales rate. There is also still a substantial shadow inventory of houses that will be foreclosed on in the current year, and thus be thrown onto the market.
Rising employment levels means that the rate of household formation should rise a bit, but not enough to really wipe out that inventory overhang. The 9.5 month level is about where it was during the worst of the housing price decline in 2008.
Under those conditions, I find it hard to see house prices rising in 2011, but since houses are much more affordable now than they were back then — and the ratios of housing prices to both rents and incomes are back down near historically normal levels — I doubt we will see a repeat of the 30% price drop we saw in the first down leg of housing prices.
More likely the decline will be held to between 5 and 10%, as measured by the Case-Schiller 20-city composite index. Put me down for a 7.5% decline as the midpoint of that range. That will still be extremely painful — and it means that many more people will find themselves owing more on their mortgages than their houses are worth, aka being underwater on their houses.
Currently about 23% of all houses with mortgages are underwater. A 7.5% decline would push that figure up towards 30% (offset a bit by the actual foreclosures, since then those people would no longer have either houses or mortgages). By late in the year, we should start to see some improvement in the housing market.
The process will not go on forever, and eventually a higher population, and higher household formation will mean a greater demand for housing. The actual inventories of new homes are at near-record low levels, and the homebuilders have more or less stopped building in 2010.
It will not take very heroic levels of either new home sales or housing starts to generate some very impressive-looking percentage gains. That, however, is more likely to be a second half of 2011 or 2012 story than a early 2011 story.
To sum up, here are my fearless forecasts; all are year-end levels unless noted:
S&P 500 1,400
S&P 500 EPS $95.00
Jobs Created 2.0 million
Unemployment rate 9.1%
CPI 2.2% (avg. for year)
Core CPI 1.5% (avg. for year)
Oil Price $105
Natural Gas Price $5.25
Fed Funds 0.0% to 0.25%
10 year T-note 4.25%
30 year Mortgage 5.25%
Home Prices -7.5%
Budget Deficit $1.4 trillion
Zacks Investment Research
