The U.S. stock market has had quite the year, from the 20-minute “flash crash” back on May 6, 2010 to the 10% overall market return. No one knows exactly what the future will bring, but there are plenty of theories. (Of course, that if anyone tells you that she knows for sure, that’s a clear sign that she doesn’t!) This holiday season, as you listen to people ruminate on the future of the economy, keep in mind these three potential stock market trends for 2011 and beyond:
Possibility #1: The Market Goes Up
Commonly referred to as the “bull” case, the famous Warren Buffett seems to subscribe to this view, as he has been quoted as saying that he expects the economy to be better in two years than it is now. Here’s how the argument goes: After a rough ten year stretch in the early part of the millennium in which stocks went nowhere, the high excesses of the ‘90s have been wrung out of stock prices. Relative to the earnings potential of U.S. companies, stocks are reasonably priced. So, as the economy continues on its tenuous path to recovery, stocks should continue to march upwards. This is supported by the fact that dividend yields on blue chip stocks are higher than those on five- and 10-year government bonds. As such, investors seeking “yield” or “income” will be drawn to stocks, which will in turn cause the market to rise.
Possibility #2: The Market Treads Water
In this scenario, the market moves up and down but ends the next year (or two or three) essentially where it is today. The argument here is that the positives mentioned in #1 above will be offset by a variety of negative forces. For instance, individual investors may remain averse to risk and be unwilling to move their cash back into the stock market. Additionally, many companies may be reluctant to spend the cash on their balance sheets. It’s like trying to play musical chairs when no one is willing to get up with the music: It ends up being a pretty boring game.
Possibility #3: The Market Goes Down
This is known as the “bear” case. Common arguments for why the market is in trouble: Impending domestic debt crisis on the federal and state levels, high unemployment, a weak dollar, lack of confidence in our overall financial system, and more attractive opportunities for growth overseas. In a nutshell, the “bears” believe that the financial foundation of the U.S. is sufficiently shaky that even if some individual companies (like Apple, Amazon, or Google) continue to perform well, the market as a whole will not rise because there are too many structural problems that will keep investors out of the market.
Which scenario will win? It’s anybody’s guess. That’s why we recommend taking the long-term approach of investing with low-cost index funds that cover a mix of stocks and bonds appropriate to your age. Whichever path the market ends up following in the near term, always remember that you should only be investing if your goals are more than five years away—so that the short-term bumps will be mere turbulence, not strong enough to knock you off the road.