This blog is part of a larger white paper we’ve recently published titled: Opportunities and Risks in 2011.  Click on that title to read the full version.

As always, I won’t make any predictions for the coming year as the value in precise market predictions – such as what the S&P will end the year at, or what asset class will perform best – is fruitless.  Like life, investing is a journey and there are typically many challenges along the way.  It is practical though to know the state of the markets, risks facing the markets, a course to take, and plans for contingencies.

This year is opening up much like 2010 with Europe still sending global shock waves with its ongoing debt woes, unemployment in the United States still too high, the U.S. Government building a catastrophic amount of debt, and U.S. housing still under pressure.  The new worries hanging over the market going into 2011 are the debt issues of the individual states in America, surging food prices around the world, and a trade/currency war.

Coming into 2011, the U.S. stock market (as gauged by the S&P 500) has gone up since this past September putting it well into overbought territory.  There are plenty of readings that investors can use to gauge how long-in-the-tooth a market rally has become.  Let’s consider a few contrarian indicators:

  • As of January 5th, the percent of bulls in the American Association of Individual Investors poll was 55.9% – higher than its’ 2007 peak.
  • On January 5th, the National Association of Active Investment Managers survey that measures the equity exposure of its members came in at 78.5%. This is near levels reached in April 2010, just before a 16% drop.
  • The NYSE Bullish Percentage Index sits at approximately 80%. This indicator simply outlines the percent of NYSE stocks trading on a bullish signal. In 2010, when the 80% handle was reached for this index, 6% and 16% drops followed.
  • The VIX (or fear index) measures how concerned options traders are that prices will drop.  As with all sentiment indicators, the value of the VIX lies in its contrarian application. Over the last month, the VIX has been around 17. The last time the VIX spent time in the 17 area was the spring of 2010, just before a 16% drop.

It is safe to say that a pullback in the market is not far off, and that right now there is more downside risk than upside possibility.  Any drop in the market in the short-term will likely present a buying opportunity.  My outlook for the U.S. market through the summer of 2011 is positive (thanks to the Fed priming the money pump); however, beyond the summer things could get dicey again.

We can thank global central banks for both the opportunities and risks that we face in 2011.  Let’s make sure we are on the same page and understand that central banks are creating inflation, as they are the only entity that can control the money supply.  Inflation by definition is the expansion of the money supply; the result of the expansion of the money supply is rising prices.  Do we have inflation right now?  Yes.  The money supply has exploded in the last 10 years.  The results of the flood of money are being felt heavily in the emerging markets as rising prices have already set in.

The single most important item that all investors must recognize at this point is that bond funds hold risk.  As the global markets unwound in 2007-2008, scared investors ran to bond funds.  Now, as stocks have become more attractive, and interest rates are beginning to rise from the ashes, bonds face serious head winds.  If you think you can hop across the pond and pick up foreign bonds to tame the risk, think again. The currency tensions are wreaking havoc on global bond funds as well.

If you would like to discuss your current investment strategy, take advantage of our free investment analysis, or have any questions, please give me a call at 913.693.7918, or email me at [email protected], to schedule your free consultation.

John P. Chladek, MBA, CFP® is the President and Founder of Chladek Wealth Management, LLC, a fee-only financial planning and investment management firm specializing in helping families and couples who are not yet retired realize their financial goals.  For more information, visit http://www.chladekwealth.com.

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