Second Verse, Same as the First? - 01/03/11

Meet the new year, same as the old year -- for now.

I'm Henry the 8th, I am
Henry the 8th, I am, I am.
I got married to the widow next door.
She's been married seven times before.
And every one was a Henry (Henry).
She wouldn't have a Willy or a Sam (no Sam).
I'm her 8th old man, I Henry.
Henry the 8th, I am.
Second verse, same as the first.

-- Herman's Hermits, "I'm Henry the Eighth, I Am"

Overnight futures and European market gains are emboldening the exercise of extrapolating the remarkable December market gains.

The media and strategists (in particular) are almost universally optimistic and remarkably certain and confident of view.

With few exceptions -- here is one -- a smooth and self-sustaining economic expansion has now become consensus.

My hedge fund cabal, though a relatively small sampling, is talking bearishly but investing bullishly.

I continue to see risk in the unresolved tension between the short-term tailwinds of monetary stimulation and the longer-term headwinds of fiscal imbalances (local, state, federal and non-U.S.), a reluctance to move on the domestic deficit, the inevitability of higher marginal taxes, the screwflation of the middle class and other nontraditional factors. More immediate, a still-moribund housing market, vulnerable corporate profit margins, and rising food, energy and interest rate costs are causes for concern.

An unusual impediment to smooth and self-sustaining recovery is a relatively anemic trajectory of expansion -- "it's different this time" - which exposes the slope of the recovery to policy mistakes, the long tail of the last credit cycle and other unexpected and exogenous events. This should limit valuations and most likely result in a contraction in P/E multiples during this year.

No doubt the trend remains the friend of investors in early January, as the second verse (2011) appears to be starting off resembling the first verse (2010). Nevertheless, my baseline expectation remains for a sideways/flat market in 2011 that should provide numerous trading opportunities (of which I plan to make you all aware on The Edge) for those willing to sell the rips and buy the dips.