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My Economic Forecast for 2011

Paul Goodwin offers his forecast for the economy in the new year.

My Economic Forecast for 2011

Caroling

Hot, Fresh and Risky

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It’s easy to say that Cabot’s growth investing disciplines don’t try to anticipate what the market is going to do next.

After all, the Cabot Tides, Cabot Trends and Two-Second Indicator, as well as the Cabot China-Timer, are all market trailing measures. (That means they’re based on how the market has performed in the past, not how we think it’s going to do in the future.)

But this is also the time of year when we are contacted by various publications and columnists who want to know our economic and market outlooks for 2011. They also want our picks for the top stocks of the coming year.

So on the one hand, we have our time-tested principles telling us to refrain from predictions. And on the other hand, we have opportunities for exposure and publicity that might bring us to the attention of potential subscribers.

Guess which hand wins?

Accordingly, since it’s a season for sharing, here are my personal thoughts on what the economy and markets might do in 2011.

Right now, U.S. equity markets (as measured by the S&P 500 Index) are at their highest level since September 2008. The current rally began back in March 2009, but 2010 brought two major corrections that kept investors’ spirits restrained until recently.

Now, however, sentiment has improved to the point that hot money has been sloshing into the market. Investors are also being pushed toward stocks as interest rates begin to inch up from their historic lows.

Elevated sentiment is always a precursor to a market correction, just as depressed sentiment eventually gives way to a new rally.

I can’t say when the correction will begin, or how long it will continue. But given the altitude the market has attained, the fall is likely to be significant, say 5% to 10% or even more.

At times like this, I think it’s good to keep in mind one of my favorite stock investing maxims. “The market wants to take your money.” It’s not on your side; it’s not even neutral. It will keep rising until it lures the cautious and conservative off the sidelines, then it will clean them out with a well-timed dip.

And when it has finally ground all the optimism and hope out of the most enthusiastic investors, it will turn around and start rising again.

It’s not cheap irony, it’s expensive reality.

And the people who thrive are those with either the discipline to buy at the bottom (value investors) or those with the discipline to jump in on the rallies and jump off when it become evident that the tide has turned (growth investors).

But I digress.

I see the global economy gathering strength during 2011. China’s careful tightening of the economic screws will moderate growth there to about 9% annually. Europe will grow the slowest of the major regions as it digests bailouts of two mid-sized economies (Greece and Ireland) and tries to prepare for possible crises in Spain and Italy.

The U.S. economy will benefit from the stimulative effect of tax cuts, but employment will continue to lag as small and medium-sized businesses—still bruised by the layoffs they had to make during the Great Recession—will delay hiring as long as possible.

But once hiring begins—and it may not actually take off during 2011—the U.S. economy will grow rapidly. Job creation is the sticking point, and when jobs appear and the economy starts growing, the financial sector will begin to grind through its continent of toxic assets. But that will be the final step of economic recovery, not the first.

Now, please note that I personally wouldn’t invest a dime based on my predictions, nor those of any other fearless prognosticator. I prefer the nice, grounded feel of reality under my feet that I get when I follow the market rather than trying to get ahead of it.

But a combination of instinct, indicators and common sense tells me that a correction is coming, and I may be a little more prepared to trim my sails and cut my losses when it shows up.

If you’d like the benefit of some reality-based advice on investing in China and the emerging markets, you can take a no-risk trial subscription to Cabot China & Emerging Markets Report.

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Insert Christmas Carol image here! I don’t collect many things, but over the years I have accumulated more than a dozen printed editions of A Christmas Carol by Charles Dickens. There’s always a good reason for a publisher to print a new version of an attractive holiday story that’s in the public domain, and I own a couple that date back to the 19th century.

I just enjoy books in general, and I appreciate the differences in the illustrations over the years. In some editions, Tiny Tim looks more like a beaming picture of health than a crutch-wielding waif with a life-threatening condition.

Scrooge can vary from skeletal to robust and the Ghosts of Christmas Past and Present give free rein for artists’ imaginations.

And the story, which Dickens turned out in six weeks in late 1843, is full of his sympathy for the poor, especially the young poor. There may be a few people who can get through a full reading, theater production or movie of A Christmas Carol without at least one tear in their eye, but I don’t want them at my Christmas party.

The book is full of Dickens’ social criticism, but it was a distinctly commercial venture, with Dickens refusing a lump sum payment and financing the publication himself, with a percentage of the profits in mind.

I doubt I’ll ever be in the market for the first 1843 edition, which now fetches a five-figure price, but I’ll continue to snap up old examples when they appear. Editions from the 1940s and ‘50s are nicely priced right now.

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IPOs are always risky, and those of Chinese companies are especially so.

Still, a Chinese enterprise with very a very attractive story has recently come public on the New York Stock Exchanges as an ADR (American Depositary Receipts). Listing as ADRs confirms a company’s commitment to abide by U.S. accounting standards, including compliance with Sarbanes/Oxley regulations. This is a significant boost to the reliability of revenue and earnings reporting.

The company is E-Commerce China Dangdang (DANG), known as Dangdang to its friends, an online bookseller that’s been following in Amazon’s footsteps by growing out of that category and into online retail selling of just about everything. So far the company has edged into beauty and personal care supplies, and its website provides a place for outside merchants to sell all kinds of merchandise.

The company is tiny (market cap of just $564 million), with annual sales of $298 million. Dangdang was founded in 2000, and turned its first profit in 2009. Q3 results showed a 200% increase in earnings on a 59% jump in revenue. The after-tax profit margin was 5.4%.

The stock doubled from its IPO price of 16 and hit 33 on December 10. The key will be to watch for the traditional post-IPO droop, perhaps reinforced by a correction in the broad market, and to buy DANG after it forms a new base at a significantly lower price, probably in the low 20s.

Sincerely,

Paul Goodwin
For Cabot Wealth Advisory

P.S. Paul is the editor of Cabot China & Emerging Markets Report, which Hulbert Financial Digest named the #1 newsletter for five-year performance in 2009 and 2010. It’s also the place to find the best stocks in the growing BRIC (Brazil, Russia, India and China) markets. Find out what Paul’s recommending today!

Paul Goodwin is a news writer for Cabot’s free e-newsletter, Wall Street’s Best Daily.