Creation in the Quantum Foam Casino

Creation in the Quantum Foam Casino
A Scientific Narrative from Before “The Beginning” to After “The End”

The Regulators of the Quantum Foam Casino are not the Bureau of Indian Affairs or the Nevada Gaming Commission, but the 1st and 2nd Laws of Thermodynamics. The driving force, however, is the pure probability of quantum mechanics, hence the casino reference. I began formulating ideas about “Creation” by studying the work of approximately 25 the of the most insightful intellectuals on our planet: Shing Tung Yau, Andrew Strominger, and Lisa Randall from Havard, Ed Witten and Juan Maldecena from Princeton, Brian Greene from Columbia, Alan Guth from MIT, Leonard Susskind and Andre Linde from Stanford, Stephen Hawking and Michael Green from Cambridge, Laura Mersini-Houghton from North Carolina and Cambridge, Joe Polchinski from UC Santa Barbara, Jacob Bekenstein from Hebrew University, and John Schwarz from CalTech. I also credit the greatest minds of the past century by using the work of Albert Einstein, Max Planck, Erwin Schrodinger, Werner Heisenberg, Niels Bohr, Richard Feynman, and others who laid the groundwork of theoretical physics. I synthesized ideas from these folks and then used logic, interpolation, symmetry, extrapolation and a little imagination to formulate a narrative of creation from before “The Beginning” to after “The End” with a high plausibility quotient. This has been an extremely rewarding and challenging thought process for me, and my hope is that my excitement infiltrates my writing and provides perspective and food for thought for folks who like to dig a bit deeper into reality. I don’t mind if someone called this work science fiction as long as it’s written as “science fiction” or the science is shouted and the fiction is whispered, since about 85% is science fact with about 15% scientific speculation. It is now widely accepted that we circle an ordinary star within an ordinary galaxy. There are approximately a quarter trillion galaxies, with each galaxy containing perhaps a quarter trillion stars within our observable universe. Our universe, however, is most likely much, much larger than the approximately 40 billion light-year diameter that comprises the observable part. Additionally, recent evidence points to our universe being one of a near infinite number of universes, hence the term Multiverse. We are indeed small and insignificant! This should not be a reason for despair, but an inspiration to make the most of our unimaginably tiny corner of the Multiverse. I’m going to try and tie together the following sections into a cogent narrative of creation: Thermodynamics, String Theory, Quantum Vacuum States and Inflation Theory. The last section describes how our Universe will ultimately end.


Thermodynamics

The traditional 1st Law of Thermodynamics was derived in the 19th century and states that energy is conserved. It cannot be created or destroyed, but can be converted from one form to another. This fundamental law was good for steam engines and is equally good for our Universe, but is a bit parochial for Multiverse applications and therefore needs to be generalized. The 1st Law in its most general, symmetrical form should read: Total net energy content of the Multiverse is zero, although dipole energy components can be infinite as long as they are conserved by an equal amount of diametrically-opposed energy. Dipole energy refers to the fact that all energy must be balanced or cancelled out by the same amount of diametrically-opposed energy. Negative energy can also be used to describe diametrically-opposed energy, although the sign is arbitrary. This is not about an anti-matter or Warp drives from Star Trek because both anti-matter and regular-matter are composed of positive energy. When they annihilate one another they release positive energy (and power the Enterprise). The Multiversal 1st Law boils down to symmetry as well as conservation of energy. The sum of the dipole energy components must equal zero. Let’s look at various manifestations of dipole energy.

The vacuum of space-time in our Universe is not nothing (a double negative is appropriate here). It is a seething cauldron of quantum fields and a zoo of particles and anti-particles. Many of these particles are “virtual” particles. Virtual particles come into and out of existence within the Planck time of 10^-43 seconds. The Planck scale equates to ~10^-43 seconds (a decimal followed by 42 zeroes and then a one), and ~10^-33 centimeters. Planck scales derive from the physical limits of our Universe; the smallest gamma-ray wavelength that can exist without forming a space-time singularity according to General Relativity, and the time it takes for light to travel that distance. Virtual particles interact with real ones during their brief lifespan. Modern quantum field theory states that forces are mediated by fields that are the result of all interactions that a particle encounters, both real and virtual, averaged over space and time. One manifestation of this is a phenomenon called “pair production.” Particle/anti-particle pairs are constantly being produced and annihilated via natural quantum processes, even at absolute zero temperature in complete vacuum (absolute zero pressure). When a virtual particle pair is generated near the event horizon of a black hole, one of the particles can be sucked into the black hole before the pair can cancel each other out. The mathematics for this phenomenon were worked out by the British physicist Stephen Hawking in 1974 and is generally accepted today. The remaining particle can become a real photon and radiate into space. This is the mechanism for black hole decay via Hawking radiation. The result is a “negative energy” hole left in the vicinity of the black hole event horizon that is instantly filled with positive energy from the black hole itself. Since E=mc2, the lost energy from the black hole is manifested as a loss of mass, hence the black hole shrinks. A real positive energy particle is created at the event horizon out of nothing but quantum fluctuation, and is accounted for by an equivalent negative energy effect on the black hole.

A similar phenomenon called the “Casimir effect” has been confirmed by experiment. Two metal plates that are placed in close proximity to one another in complete vacuum at absolute zero temperature experience negative pressure and are sucked together simply because of disruption in the quantum wave patterns between them in a zero energy environment. This is another manifestation of negative energy.

The prior arguments lead us to negative energy in its most basic and pervasive form. It’s all around us and we experience it constantly; gravity. In most cases gravity can be assigned a negative sign because we think of positive energy (thrust) as being required to attain escape velocity and overcome a gravitational field. Consider that when you throw a ball into the air you impart kinetic energy to the ball that is drained by gravity. When the ball hits its peak it has no kinetic energy and maximum gravitational potential energy. As the ball begins its descent, its kinetic energy increases at exactly the same rate that its gravitational potential energy decreases. Also consider how gravity cancels out the energy of matter and light inside a black hole. Some physicists believe our universe will end with all matter and energy being crushed out of existence in 30 billion years or so in what’s called the “Big Crunch.” Is that not a good argument for gravity being considered “negative energy?”

The traditional 2nd Law of Thermodynamics states that entropy must increase for any spontaneous process. Entropy is precisely defined as the logarithm of the number of different microstates in a system that comprises a given macrostate. The traditional definition for entropy is that disorder must increase in any closed system over time. For steam engines, this meant that heat loss ensured that a perpetual motion machine could not be created to power railroads. In modern physics, entropy is thought to set the direction of time flow in our Universe, from lower to higher entropy (disorder). Time began to flow within the first second after initiation of our universe as a result of entropy that was much lower than the maximum over our region of newly created space-time.

A compelling argument for negative energy can be made out the fact that regions of minimum gravitational potential energy and maximum entropy (disorder) in our Universe are black holes. Conversely, positive energy regions of minimum potential energy and maximum entropy occur where matter, field strength, and energy are as randomly dispersed as possible. This would occur, for example, at a point of heat-death when the average temperature of the Universe asymptotically approaches zero. These two conditions for minimum potential energy and maximum entropy are diametrically-opposed.

A circumstantial argument for the existence of negative energy stems from the simple fact that no one, not even Albert Einstein has been able to develop a Grand Unified Theory of all known forces. Three positive energy forces (electromagnetism, strong and weak) have been unified for decades. The fourth force, gravity, has not easily conformed to any mathematical framework for unification thus far because it is fundamentally different, a universally opposing force or energy source.

Another circumstantial argument for the perfect balance of energy dictated by the 1st Law comes from what’s called the “critical energy density.” This term refers to the balance of energy per unit volume that determines the “flatness” of our Universe. It turns out that any deviation beyond 1 part in 10^15 (a one followed by 15 zeroes) at one second into our Universe’s evolution would result in dramatic effects on space-time over billions of years and would preclude evolution of intelligent life like ours. This is because of positive feedback effects of positive energy (expansion) and negative energy (gravity). Even a tiny excess of positive energy above the critical density would have already resulted in an “open” Universe which would have already expanded beyond the point where galaxies could coalesce. And a tiny deficit below the critical density would have already resulted in a “closed” Universe where a “Big Crunch would have transpired billions of years ago. Our Universe had a perfect balance of positive and negative energy because that is the only way it could have formed in the first place according to the 1st Multiversal Law.

Finally don’t forget the most fantastic negative energy manifestation of all, a scifi favorite; the wormhole. Nothing in our known laws of physics precludes creation of a wormhole. Theoreticians currently speculate that creation of a wormhole would require “negative energy” to keep it open (allowing the Stargate SG-1 team to defeat the Gu’ Ould).


String Theory

String theory has been around for about 40 years now. It elicits passion amongst physicists because, in spite of its fundamental force-unification potential, some of its predictions are outside the realm of experimental or observational falsification. Not to mention the mathematics are extremely dense and prone to many approximations and assumptions. String theory keeps coming back because it avoids theory-dooming singularities (infinite solutions) that plague other theories, and provides a potential avenue to unify the four fundamental forces. Shing Tung Yau did groundbreaking mathematical work on 6-dimensional manifolds (surfaces) in the late 1970’s, using a conjecture that geometer Eugenio Calabi “through down” in 1953. The characteristic 6-dimensional shape of a given Calabi-Yau manifold determines the potential vibrational patterns for string energy and thereby the particular physical laws that govern a universe like ours. Yau’s geometrical discoveries were used by physicists to revive string theory in ten dimensions (4 for space-time and 6 more Calabi-Yau dimensions at the Planck scale). Later it became known as Superstring theory due to mathematical discoveries concerning the symmetry of all force and mass particles. By the 1990s, the problem was that there were five distinct string theories that didn’t mesh. Ed Witten consolidated them in 1995 by introducing M-theory, which required an eleventh dimension. This discovery ushered in the concept of “branes,” or multi-dimensional “scaffolds” of string energy. Positive energy strings such as photons, electrons, quarks, gluons, W and Z weak force particles are composed of open-ended strings that require a scaffold or brane to attach to. Gravitons, on the other hand, are closed energy loops that can move freely amongst different branes. Recent evidence suggests that the eleventh dimension from M-theory need not reside at the Planck scale, but could be much larger, although it’s still hidden from our 3 space dimensions. The best way to visualize multi-dimensional branes is to think of them as “stacked” on top of one another. A brane can “warp” space in its vicinity and thereby influence other branes in the stack. Our 4-dimensional space-time brane floats atop the stack. Branes have gauge fields associated with them that emit fluxes. Brane fluxes influence the shape of 6-dimensional Calabi-Yau manifolds by the way they wrap, deform, and ultimately stabilize them. Branes therefore not only provide scaffolding for strings but influence their potential vibrational modes by determining the shape of the Calabi-Yau manifolds. A fantastic number of possible vacuum configurations derive from how string energy coalesces onto n-dimensional, n-stack branes. Theoreticians estimate that there may be 10^500 (a 1 with 500 zeroes in front of it) different possible combinations. Each distinct shape would result in a distinct vacuum energy state, and each vacuum state would ultimately result in different particles identities and physical laws. This is such an enormous number that it dwarfs the number of seconds since “The Beginning,” or the number of particles in our entire Universe. Now you get an idea why some scientists don’t like string theory!

If string theory is correct, one of the branes in our Universe is a two-dimensional brane directly underneath our four-dimensional space-time that stores all the information in our universe, and is the source of two fundamental laws: the Unitary Principle (Conservation of Information), and the Holographic Principle. Information is always conserved within a Universe, as is momemtum, charge, and energy. A Multiversal corollary of this law is that no information can ever pass into or out of our Universe. The Holographic Principle was first derived from work on black holes. Surprisingly enough, all the information of a black hole is stored in the quantum fluctuations at its surface. The matter and energy a black hole absorbs is related to its surface area, not its volume. If you ventured into a black hole, you would of course be ripped apart by the tidal forces of the singularity, but an outside observer would see you slow down near the event horizon and become a permanent smear on the surface. In fact as mentioned earlier black holes are regions of maximum entropy (disorder) in our Universe. The entropy of a black hole can be calculated by dividing its total surface area by the smallest surface that can exist in our Universe, a Planck length squared (10^-66 cm2). Therefore information from everything that happens within our 4-dimensional space-time is stored as a hologram on a two-dimensional brane surface that may only be micrometers away, but cannot be seen or detected. The Holographic Principle has other manifestations as well, one of which is called “Duality.” Duality means that a phenomenon in 3-dimensional space-time can be mathematically described just as easily or sometimes much easier as a two-dimensional process.

A fascinating sidelight to the 2-brane information model is that it also might explain a mystery that Einstein called "spooky action at a distance." Quantum entanglement links two particles together over any distance within our 4-brance space-time, and has been one of the more confounding aspects of quantum mechanics. The particles are linked instantaneously and are not bound by the speed of light. The information from entangled particles could reside on the informational 2-brane that resides in our Universe. Since the speed of light would not be a constraint on the informational 2-brane, it would explain the instantaneous "spooky action at a distance."


Quantum Vacuum States and Inflation Theory

“Quantum foam” was originally used to describe chaotic quantum vacuum fluctuations occurring in our Universe at the Planck scale. A broader Multiversal definition of quantum foam must include fluctuations occurring in a pre-space-time domain at a “ground-state” energy level, as opposed to the elevated energy state of the vacuum in our Universe. Multiverse quantum foam therefore is not bound by the same constraints or physical laws, because those laws are determined after creation of a new universe has commenced. The main point here is that Multiverse quantum foam exists at a more fundamental, lower energy vacuum state than anything that exists in any universe because of the residual “dark energy” content of space-time (more on this below). Time may flow in both the forward and backward directions in ground-state quantum foam. Ground-state entropy is chaotic and near a local maximum, but no matter how extreme the disorder is, there is still a non-zero probability that ordered states can appear. Just like if you ate enough alphabet soup, at some point you would see your full name spelled out perfectly in the bowl! Backward flowing time is in fact consistent with known physical laws of today, which do not distinguish between the directions of time. Studies on entropy also allow for waves or small domains of increasing order (reduced entropy) as long as overall entropy increases. “Scalar” fields are theorized to arise naturally from the Multiverse quantum foam, although none have been found in the low-energy physics of today. Fields we know of like electromagnetism are vector fields and obey the inverse square law, meaning they get weaker according to the square of the distance from the field’s epicenter. A scalar field’s energy density is constant at each point in space, although it varies within an overall domain according to quantum fluctuation. An “Inflaton” field is a scalar field composed of negative energy in the form of pervasive negative pressure. General Relativity has a pressure term embedded in the tensor equations. Pressure can curve space-time in the same way that energy and matter do. If you weighed two pressure cylinders, one under vacuum and the other under pressure, and then subtracted out all the molecules that produced the pressure, the vacuum cylinder would still weigh slightly less, due to pressure exerting a gravitational effect above and beyond the weight of the mass. In the case of the Inflaton field, we’re talking about an enormously negative pressure that permeates quantum foam and causes gravity to change signs and become repulsive. Gravity was so repulsive in fact that our incipient universe swelled by a factor of a minimum of 10^30, possibly much more. This tremendous swelling of space-time coupled with a scalar field’s constant energy density accounts for all the energy in our Universe today. It would have taken our incipient Universe from just above the Planck scale to a size bigger than our solar system and infused it with a huge amount of positive energy within one second. All this positive energy was balanced by an equivalent, opposing amount of gravitational potential energy according to the modified 1st Law of Thermodynamics. The negative pressure of the Inflaton field caused gravity to become schizophrenic and feed on itself!

Quantum fluctuations in the true “ground-state” energy of Multiverse quantum foam create roiling bubbles of potential universes that come into and out of existence, in much the same way that pairs of virtual particles do within our Universe. Some of these bubbles can reach an energy density that result in Inflation, and some of the space-time created by Inflation result in universes. Most of these are what’s called “terminal” universes, meaning they had insufficient energy density and re-collapsed on themselves because of gravity. A viable universe is created once in a trillion tries or more that can support physical evolution of galaxies and hence biological evolution according to quantum probability. Once Inflation passes a threshold energy density, however, current models suggest it would be very hard to stop. Like a wildfire in a tinder-dry forest in the western U.S.! Since Inflation is the process that creates space-time, the largest energy densities would inflate most rapidly and dwarf all other regions of space-time.

What happens next is just as remarkable! An Inflaton field is inherently unstable according to quantum uncertainty and can decrease to a much lower potential energy vacuum state, releasing most the Inflaton potential energy in the form of particles that comprise our low-energy universe today. Other regions can continue to inflate to near-infinity. A region of condensing Inflaton energy is called a “valley” in quantum lingo. All this energy was exactly balanced by gravitational potential energy, so that the total energy expended during Inflation was zero. The end result would be a domain that looks like a gargantuan sponge (if you could pull back and look at the “big picture,” which you can’t, even in principle). The air pockets in the sponge would be universes. A metaphor for Inflation Theory is a “Big Balloon,” not a Big Bang! Inflation started at 10^-35 seconds (a trillionth of a trillionth of a hundred billionth) and ended about ten times that amount of time later, at 10^-34 seconds. The condensation process that released most of the Inflaton energy as particles in a brand-new space-time would have been much slower, but still occurred within the first second of creation. The potential energy valley achieved post-condensation was not a ground-state, however. Physicists now believe that “dark energy” is composed of residual energy density level left over after Inflation. It’s the potential energy vacuum state that has persisted from post-condensation to the present day. This description of dark energy is supported by General Relativity and embodied by the “cosmological constant” that Albert Einstein included in his tensor equations in 1915. He originally did this to conform to the “static space” concept that most scientists believed at the time. Later when Edwin Hubble discovered that space was expanding, Einstein regretted inserting a cosmological constant into his equations. But after supernova experiments determined that space was actually accelerating in 1998, Einstein was vindicated.

The 2nd Law of Thermodynamics is responsible for the forward flow of time. In other words, time must flow from an orderly state toward a disorderly state. Within the first second of creation time begins ticking. Specifically this event starts at the moment of decay of the Inflaton field, when positive energy is released as precursor particles and the universe heats up as it oscillates and searches for a final potential energy resting place. Inflaton potential energy decay is a condensation of string energy. String energy condenses onto brane scaffolding as the many dimensions randomly find their lowest energy, most stable resting place. A post-condensation universal structure is a relatively orderly region of coalesced strings, branes, dimensions, and precursor particles. Our Universe heated-up to around 10^32 K through oscillations of the Inflaton field as it tried to settle down into a lower, stable, resting energy state. Inflation essentially re-shuffles the cards of potential physical laws for a new universe because the final potential energy resting place could be any of 10^500 vacuum states. The structure contained in a new post-condensation universe results in a relatively low entropy region compared to a completely random region of maximum entropy. This process compels time to flow from lower to higher entropy in the new universe, while total entropy increases in the Multiverse. Entropy increases as new space-time is created, providing an enormous new macrostate, or entropy playground! So even though ground-state quantum foam exists near a local entropy maximum, there is no such thing as Multiversal maximum entropy. Entropy can continue to infinity!

The next time you pick up a rock on the beach or the trail you’re on, remember that rock is nothing more than condensed Inflaton energy, and how lucky you are that it wasn’t from a terminal universe or one that didn’t have the physical laws that could ultimately support biological evolution. You drew a royal flush in the Quantum Foam Casino!


The End of Our Universe

Our universe will end in “heat death.” The average temperature of our Universe today is 2.7 oK according to measurements of cosmic microwave background radiation. In approximately 75 billion years, as our Universe continues to expand and cool, the average temperature will asymptotically approach 0o K. All that will be left are black holes, neutron stars, and stray photons. Of course quantum fluctuation will continue unimpeded for trillions of years after all life forms are extinguished, as long as the structure of space-time is intact. What if space-time is ultimately not left intact? A more dramatic and symmetrical ending could result if a special type of quantum fluctuation called quantum tunneling were to happen. Quantum tunneling occurs when a probability wave is impeded from reaching a lower, more stable energy state because of an energy barrier. An unlikely outcome in quantum mechanics can be realized even if it appears to be blocked by an impenetrable barrier since no probability is zero (or one). With respect to the end of our Universe, a tunneling event would result in vacuum decay back to a ground-state energy level. It would cause all the dark energy in our Universe to be released nearly at once in a great unwinding of our space-time structure. Our Universe with all its stacked branes of string energy in its 11-dimensional configuration would implode at far greater than the speed of light. The only difference between the starting and ending points would be that total entropy of the Multiverse would have increased. One elegant feature of this theoretical event is the symmetry it implies. If our Universe were to unravel due to a quantum tunneling event, it would then revert to its starting point as ground-state energy quantum foam. The great release of dark energy, and a commensurate amount of gravitational potential energy, would not be an event of creation, but of destruction. Energy would be re-absorbed into the Multiversal quantum foam, and revert back to the original ground-state vacuum where scalar fields naturally arise. Our Universe could be recycled into another space-time in another eternity!

If humans escape this rock we live on before destroying themselves, no matter how smart they are, they will never escape to another Universe. That means that the most advanced civilizations will perish with our Universe in about 75 billion years. No matter how much technology a civilization possesses, they will be doomed to extinction in the end because of the Unitary Principle. They ultimately cannot achieve the status of “gods.” Of course life can achieve Universal immortality through technology by combining neuroscience with computer technology. That would endow a biological-computer hybrid being with potentially billions of years of existence, but not eternity. Time will run out in this Universe, just like it has/will for an unfathomable number of different universes. Advanced beings of the future could become “gods” by creating universes if they intimately understand Inflation physics because it fundamentally does not require a large energy source. It supplies its own energy! But they still could not visit or communicate with their new universe because of the Unitary Principle and the uncertainty of physical laws that would be associated with a new universe. It would be like trying to communicate with a black hole or to penetrate the event horizon of our Universe. It can’t happen even in principle!

We are profoundly insignificant in the grand scheme of things. This knowledge makes it even more important that we make a difference on this tiny planet in our tiny solar system in our tiny galaxy in our tiny universe. It’s the only one we will ever have!

2011 Global Financial Market Predictions

I. U.S. Markets

2011 should be another good year for U.S. stocks, with S&P 500 returns in the range of 10%. This will occur in spite of enormous challenges, including still high-debt loads for consumers and governments (federal, state, and local), high unemployment, a moribund housing market, and rising long-term interest rates. Corporations are in good shape: debt loads are manageable, profits have bounced back from the nadir (after 7 consecutive quarters of declining profits through the third quarter of 2009, we have now had 5 consecutive quarters of increasing profits through 2010), and strong growth overseas is offsetting slow domestic growth. U.S. GDP will grow in the 3% range. This represents anemic growth for this stage of an economic recovery, where GDP should be growing in the 5% range. This shortfall is the direct result of the over-leveraging hangover of the past decade. Sub-par economic and employment growth will be the result for many years to come.
The tax compromise reached during the lame-duck Congress in December, 2010 provided some juice to the stock market and will aid economic growth slightly over the next two years, at the expense of the federal budget deficit. This compromise bill was the correct course of action based purely on economics, regardless of the politics involved. Sound economic policy necessitates that a federal government run deficits during recessions and surpluses during economic booms. This provides a counter-cyclical stabilizing force (along with Federal Reserve interest rate policy) on the economy. A good blueprint for this happened in the late 1990’s, which provided the first U.S. federal budget surplus since the early 1960’s. Reduced tax rates enacted in 2001 were also appropriate since that was a period of weak growth. The breakdown in federal tax policy happened during the economic boom years of 2004-2007, where the U.S. budget deficit never got above 3% of GDP at its peak. If we had run a surplus during these boom years our nation would be in a much stronger fiscal and economic situation today. Subsequent to the economic boom, the deficit eroded to ~10% of GDP along with the economic depression of 2008-2009, leaving the U.S. economy in a severely weakened state with few options.
The third year of the presidential cycle has historically been the best year for stock returns, and has generated only one negative return since WWII. The reason for this pattern is that the party in power wants to put policies in place in the third year so that those policies have time to work so they can retain power in the fourth year. Although I predict U.S. stock markets will increase in 2011, it will be accompanied by significant volatility. The Federal Reserve’s $600B quantitative easing program #2 is scheduled to end in June, 2011.
The best U.S. investment category in 2011 will be in the microcap area (stock market capitalization under $1.0B) and large-cap (>$10B) areas. Mid-cap ($2.5B-$10B) and small-cap ($1.0B-$2.5B) categories dominated in 2010. Microcap companies could not easily obtain credit from risk-averse bankers in 2009 and 2010, so they may be ready to finally have their day in the sun. Also, large-cap stocks have been held back the past two years by the banks. Banks returns have been miserable due to their exposure to bad loans emanating from residential mortgages and commercial real-estate. That is slowly beginning to turn around to the point that large-cap company returns should at least equal that of mid and small-caps in 2011. It’s the micro-cap area that provides the best potential in 2011 as unappealingly low interest rates more investor tolerance for risk, coupled with better access to credit make these tiny companies attractive.
The long-term outlook for U.S. stocks is not good. Growth in the U.S. should be anemic for the next decade as emerging economies become integrated with the rest of the world. The world economic pie is growing nicely, it’s just that our slice of it percentage-wise is getting smaller, causing painful adjustment in Japan, Europe, and the U.S., including falling real wages, de-leveraging, and GDP growth averaging 2.0% (instead of the post-WWII average of 3.0%). U.S. stocks look good in 2011, fueled by Federal Reserve liquidity and some bounce-back from the 2008-09 depression, but after that stocks start to look a bit dicey. Higher inflation in the out years coupled with slower growth will almost certainly lead to a contraction in P/E ratios. The current S&P 500 P/E ratio of 14 represent the post-WWII average. However, profit margins are close to a peak. Higher business input costs from rising commodities and hiring (good for the unemployed) will shrink profit margins soon. Single digit P/E ratios are historically not uncommon at all
Stock market cycles generally last approximately 20 years, and a secular bear market started with the internet bubble bursting in 2000. I believe we have about 7-9 more years of generally side-ways action in U.S. stocks between the 2007 S&P 500 high of 1550 and the 2009 low of 700 (1285 currently). So enjoy it while it lasts!
Bond markets in the U.S. had a volatile year in 2010 as anemic economic growth and Federal Reserve policy clashed with fears of incipient inflation. Junk bonds outperformed Treasury bonds slightly as fears of corporate default subsided. Fears of municipal default increased however, causing the municipal bond market to be the most volatile. Interest rates should slowly rise for the next few years, but not in a straight line, which translates to bouts of volatility. This means that bonds will return slightly less than their coupons in 2011: Low single-digit returns for the Treasury market, 5% for the municipal market and high-grade corporate market, and high single-digit returns for junk bonds.

II. Foreign Stock Markets

The three categories of foreign stock markets are: Developed (Europe, Taiwan, South Korea, and Japan), Emerging (China, India, Brazil, Russia, Indonesia, Mexico, Chile, Thailand, South Africa, etc.), and Frontier (tiniest markets in Africa, Middle East, Eastern Europe, South America, and Asia, such as Vietnam, Qatar, UAE, Nigeria, Columbia). The liquidity binge propagated by developed country central bankers is slowly migrating toward riskier assets due to unrewarding domestic interest rates and increased confidence in the world economy and banking system. Frontier market stocks were the place to be in 2010, and will repeat that feat in 2011. These markets returned ~35% in 2010 (tickers FFD and FRN). While these returns probably won’t be repeated in 2011, I expect returns in the 25% range. Emerging markets returned ~16% (tickers EEM and VWO) generally in 2010, but this value is comprised of a wide range of individual country returns. The weakest emerging market in 2010 believe it or not was China, with a return of ~3%. I expect China to do better in 2011, with returns in the 10-15% range. The strongest emerging stock markets in 2010 were in Indonesia (+40%, ticker IDX), Thailand (+50%, ticker THD), and Malaysia (+35%, ticker EWM). These returns will not be repeated in 2011 because inflation is starting to become a problem in these rapidly growing countries. Their governments are raising interest rates to combat rising prices. They are also putting restrictions on a destabilizing flood of foreign investment inflow from around the world.
One European market I like in 2011 is the Irish market. It was labeled as one of the PIIGS (over-indebted countries of Portugal, Ireland, Italy, Greece, and Spain) in 2010 and performed like a pig (down 3% when most countries experienced ebullient stock markets). The Irish have taken pretty tough austerity medicine in their federal budget and borrowed money from the EU for their banks. The market is extremely unloved, which is music to a contrarian’s ears.

III. Commodities

In general, 2010 was a good year for commodities. The broad-based commodities ETF basket (ticker DBC) was up 12% in 2010. As always with commodities, though, this overall return is comprised of a wide range of individual returns, such as palladium (ticker PALL, +79%), silver (ticker SLV, +82), gold (ticker GLD, +29%), agricultural products (ticker JJA, +38%), oil (ticker USO, -1%), and natural gas (ticker UNL, -36%). I believe these returns are part of a long-term secular trend that is based on the desires of the world’s 4 billion poor people to join the middle-class, and therefore should continue for many years, though not at the same torrid pace. In 2010 a decline in the value of the U.S. dollar juiced returns for commodities because most of them are priced in dollars (so you need more dollars to buy the same amount of commodity). I don’t expect this same tailwind in 2011 (see part IV). As is always the case with commodities, there will be huge divergences in returns. I believe the most likely winners in 2011 will be in the agricultural complex because better food is one of the first things that poor folks want when they have disposable income, and these products are much more vulnerable to unpredictable weather patterns. Most other commodities should rise in 2011, though not at the rate of 2010. I expect a volatile year for precious and semi-precious metals, including gold, silver, platinum, and palladium, with final returns up ~15%, after some huge swings and with possibly a blow-off high during the first half of the year.
The energy complex should be higher in 2011 by ~10%, with higher global economic growth outweighing abundant oil and natural gas supplies and a generally higher dollar. Oil prices should exceed $110/barrel in 2011.
The rare-earth metals complex (lanthanum, neodymium, yttrium, etc.) is a very interesting area. China mines most of the world’s rare-earths. They have made noise about restricting exports to make sure domestic demand is met. This sent the world rare earth markets (ticker REMX) into a tizzy and sent some of the western rare-earth miners stocks’ soaring. Expect more volatility in 2011, with announcements from western miners and the Chinese alternately roiling rare-earth markets.

IV. Currencies

Currency movements are driven primarily by perceived sovereign economic management, relative interest rates, and balance of trade. The U.S. dollar was abused in 2010 by the Japanese yen, Canadian and Australian dollars, and the Swiss franc, due to their perceived economic and banking stability. The U.S. dollar held its own against the euro and the British pound in a race to the bottom in 2010, as all three economies had major problems with excessive sovereign debt and anemic economic growth. The Chinese finally started to allow the yuan to appreciate at mid-year, albeit at a slow pace of ~5% per year. This should continue into the foreseeable future. This rate of yuan appreciation is not enough to make a significant impact on China’s huge trade surplus. The Chinese may increase the rate of yuan appreciation to tame domestic inflation (which is currently running at ~5%), not to appease foreign pressure on the trade front. If this happens it will be in the second half of the year.
I believe the U.S. dollar will appreciate against the euro, pound, and yen in 2011 by 5-10% due to rising interest rates and relatively better economic growth in the U.S. The U.S dollar should stay flat against the Canadian and Australian dollars in 2011 because these currencies appreciated in 2010 and are now at or near parity with the U.S. dollar, which is a level that will start to pinch their economies if it continues.

V. Final Tally on 2010 Predictions

I predicted last year that the U.S. unemployment rate would stay above 9%. It ended 2010 at 9.4%. I predicted U.S. stocks would return “high single digits” in 2010, which was low. The S&P 500 returned ~15%. I predicted junk bonds would return 9% in 2010, and they returned 12%. I predicted that natural gas prices would stabilize in 2010, but the increased supply from shale drilling has continued to weigh on natural gas in spite of good demand. I was a year early, as this same prediction should hold in 2011.
I predicted at the beginning of 2010 that gold and gold-mining stocks were a “good buying opportunity.” Gold was up 29% in 2010 and gold-mining stocks increased by 33%. Finally I predicted that the U.S. dollar would appreciate against the euro, pound, and yen in 2010 and depreciate against the Canadian and Australian dollars. I got three of five correct, as the dollar fell against euro and yen.