Why the Bullish Forecasts for 2011 Might Hit a Few Snags

The Dow Jones Industrial Average did not produce any explosive gains during the first five days of the New Year, but it did produce a “quiet” gain of almost 100 points –continuing a recent trend of steady, if unremarkable, progress.

The Dow has advanced for seven consecutive weeks, but has gained only about 100 points per week during that timeframe. So the recent price action does not feel over-the-top exuberant. Instead, it feels steady, reliable…almost predictable.

Everyone knows the market will go up next week, just like it went up last week…and the week before that. This seeming predictability is simply a different strain of irrational exuberance. When the market seems as soothing as a Corona Beer commercial, the “fear instinct” goes dormant. Investors forget to worry.

But a Corona beer commercial isn’t reality. And neither is a tranquil, friendly stock market.

Nevertheless, most Wall Street strategists have been falling all over one another to proclaim their bullish forecasts for 2011. Goldman Sachs strategist, David Kostin, is looking for a 17% rally in the S&P 500 Index this year, while most of his Wall Street counterparts are expecting at least low double-digit gains.

We hope these hopeful prognostications come to fruition. In general, up is much better than down. But it’s a long year ahead and the road to gains may not be as direct and “predictable” as the Dow’s recent performance might suggest.

The market might encounter a few bumps along the way. In fact, David Rosenberg, economist for Canada’s Gluskin Sheff, expects the market to encounter a few bumps very soon. “Signs of excessive exuberance abound,” says Rosenberg.

In particular:

  • The VIX index, at 17.5x, is back to where it was last April. Remember what happened next.
  • Investors Intelligence bullish sentiment is back to where it was at the all-time market highs of October 2007.
  • The non-commercial accounts on the CME have recently opened up a considerable net speculative long position in equities, particularly the QQQ’s (NASDAQ stocks).
  • Market leadership is narrowing, as Bob Farrell has been busy pointing out.
  • The number of short-selling positions slid 2.2% in the first half of December on the NYSE; and by 2.8% on the NASDAQ. The bears are running scared.
  • As Kelly Evans asserted last week, the AAII investor sentiment poll has been above its historical norm now for 17 weeks running – the longest stretch in six years.
  • Since July, margin debt has exploded by 16% to $274 billion, the most since September 2008 when people still thought we were in a soft landing.
  • Equity mutual funds and ETF’s took in $24 billion in December (TrimTabs data)… The last time we saw retail inflows like this into equities was last March…just ahead of a 17% correction.

Meanwhile, over in the housing market, there are absolutely no signs of excessive exuberance. In fact, there are barely any signs of anything, which is just one of the reasons why the housing market may offer one of the most compelling investment opportunities of 2011.

Eric Fry
for The Daily Reckoning