War GamesAs part of their strategic planning, the Pentagon plays out various military scenarios: A land war in Europe, a U.S. invasion of Iraq, a revolution in South America. During the Cold War, Strategic Analysis Simulation was the mother of all war games, modeling nuclear confrontation between the U.S. and U.S.S.R. These exercises allow for multiple variables and outcomes: Winning was less important than teasing out how different scenarios could unfold. Strategic planners wanted to learn how decisions were made in the field, where surprises may develop, how unforeseen events could cause a "domino effect." I used similar war-gaming techniques to consider what might happen next year. Only instead of nuclear conflagration, I think about consumer spending, corporate expenditures and hiring. What might happen to real estate prices, and how will that impact other elements? Will the demand for commodities continue to increase? Will Asian growth stay strong? What will Congress do: taxes, spending, deficits, politics? What are the political wild cards? I wonder how inflation will impact all of it, and what the Federal Reserve might do, including the expected -- and the unexpected. Barry fielded some tough questions on his thesis from TheStreet.com's Aaron Task. To watch the video,
The Crowd Is BullishThere is a lot of anecdotal chatter about sentiment , but I prefer to stick with quantitative data. I hear too many people say, "All my colleagues/friends/brother-in-laws are (fill in the blank)." That's meaningless. The Business Week survey reveals one group of bullishness. When I made my guess, I never figured I would be the outlier to the downside. Silly me. One alternative to conjuring up various scenarios would be to simply extrapolate this year into next. I suspect that's why so many forecasters cluster around the same numbers. Most of the surveyed group is clustered between 11,000 and 2,000 (about plus 5%-10%) on the Dow, while advising a 40% to 75% U.S. equity exposure. But its not just the Pros: Other surveys reveal a similar bullishness. A WSJ.com poll of more than 5,000 people taken on Dec. 30 shows 46% expect the same thing in 2006 as the market gurus: between Dow 11,000-12,000. Another 12% think we end up at more that 12,000. About 22% expect to end 2006 unchanged. Only 9% expect we will see the Dow between 10,000 and 10,500 -- a mild correction of less than 10%. Just 11% believe the Dow will drop below 10,000. This means 89% of these WSJ readers do not believe 2006 will be a substantially down year. Note that the crowd isn't extremely bullish, however. It will take one more rally toward 11,000 to get investors to breathlessly embrace the market. Then the trap door gets sprung. I understand why the crowd is so bullish. The past few years have seen terrific data points: S&P 500 earnings have grown by double digits for 14 consecutive quarters. Companies are awash in cash; they have been buying back shares at the most rapid rate we've seen since the late 1990s; more than $456 billion worth in 2005, according to TrimTabs Investment Research. Since the dividend tax rate was slashed to 15%, the number of companies issuing dividends has increased, and pre-existing yield-payers have upped their dividends significantly. That's before we get to the record-setting M&A activity last year. Despite all of these elements, the markets are essentially unchanged. Look at any U.S. index for the past one or two-year period -- or even four or five -- and there's been very little progress made. Except for the pre-Iraq war selloff and subsequent snapback, and the rally from the October 2005 lows, there hasn't been much of a market gain. Aren't you curious as to why that is?