Prediction for 2011-2012

First off, obviously this market is in full blown rally mode, and my call for a impending market top in October was premature. I underestimated the power of the Federal Reserve in convincing people that everything is going to be all right. This continuous, unbroken 4 month long rally has made even some of the so-called 'perma-bears' start to get optimistic on the economy for 2011. However, as long as the fundamentals of the economy are as bad as they are;  High unemployment, falling home prices, higher costs of living through commodity inflation, overwhelming debt in both private/public sectors, local/state governments on the verge of a meltdown, long lists of foreclosures and shadow inventory in real estate..... then I really don't see much to like in this economy.  The Fed's QE2 is yet another bubble in the making, and I don't think it will take long for it to burst once the underlying economic reality slaps everyone in the face (again).

The result of QE2 and the 4 month long rally is that we are now seeing extreme optimism in the market like I have never seen before.  By most measures, it's even more extreme than it was in October 2007 when the market peaked just before the 2008 Financial crisis. But there's an old saying, originally quoted by John Maynard Keynes:   "The market can remain irrational longer than you can remain solvent".  Now I don't agree with much of Keynes' economic views (a subject for another day), but I give credit where credit is due, and this saying is very true.  We are in rally mode, and even though investor sentiment is sky high right now, it doesn't mean that it can't go higher. But this brings me to my prediction for the next couple of years.

The year 2011 will bring a major market top in the stock market that will form a high that will not be seen in the indices for many years to come.  Our economy is way off balance, and is just teetering on the edge of disaster.  The Fed's QE2 just prolonged the rally temporarily, but it does nothing to solve the underlying issues in the economy.  In fact, the Fed's ongoing intervention (in the form of money-printing) and government stimulus has been slowly making the economy sicker and sicker, while propping up the markets artificially in the short term. The relatively few economists who understand this not only predicted the financial crisis well in advance, but have been calling for the double dip ever since the middle of 2009.  In all likelihood, the market top will form sometime in the 1H of 2011, although 2H 2011 can't be completely ruled out just yet. After this, a new bear market will be born that will last at least 1-2 years and bring us to lows we haven't seen since the early 1990's. I believe there are 2 likely catalysts that will set the start of this new bear market:  1)  Housing prices continue to fall, as they have been starting to trend over the past couple of months. OR 2) State/local government debt crisis heats up to the point where we can't ignore it anymore.  It could be a combination of these 2 things, but's the writing is on the wall... the only question is a matter of when will the bomb drop?

Cash is King.