Mel Miller, chief investment officer of Heartland Financial USA, made a lot of negative observations about the U.S. economy during his presentation on the opening day of the SRI in the Rockies conference in New Orleans. Yet he's predicting the stock market to return 10 percent to 20 percent next year. How come?

"Markets ultimately trade on earnings and U.S. corporations have been amazing at their ability to produce profits in this kind of economy," Miller said. "We run four standard models and they are all showing the stock market extremely undervalued."

Miller acknowledged the economy may go into a recession--he put it at a one in three chance--and that would hurt earnings estimates. But even when he reran his models based on that possibility and discounted earnings by 10 percent, and then 15 percent, the stock market still came up as undervalued, said Miller.

"There are some great, positive companies out there. The balance sheets of U.S. corporations have never been better. They've been paying down debt and they look very strong. Earnings look strong. So I think the market has discounted a recession already, or at least a significant slow down," added Miller, also a CFA and executive vice president at Heartland, a $4 billion diversified financial services company that provides banking, mortgage, wealth management and insurance services and operates community banks in Iowa, Illinois, Wisconsin, New Mexico, Arizona, Montana, Colorado and Minnesota.

His 2012 forecast also predicted GDP would hover between negative .5 and 1.5 percent, inflation (core CPI) would range from 1.5 percent to 2 percent, unemployment would stay between 9 percent and 10 percent, the fed funds rate would be at .25 percent and bond market returns would be between minus 2 and plus 2 percent. His statistical predictions last year for the U.S. economy in 2011 were similar and so far have turned out to be pretty much on target, except for stock and bond market returns. Rather than rising 10 percent to 20 percent, the S&P 500 index was down about 10 percent year to date as of the end of last week. And the Barclays U.S. Aggregate Bond Index has gone up about 5.7 percent rather than 2 percent.

Black swans, or at least grey swans, that clients need to be aware of, include credit default swaps, which could cause the next financial crisis, he maintained. When institutions buy credit default swaps, they are basically buying insurance that a company, or a country, won't go under, but it's unclear who is backing the insurance, Miller said.

"For two years I've been teaching an MBA class about the [recent] financial panic, and when I explain to students how credit default swaps work, they say, 'Why are these legal?' I explain to them that they were outlawed in 1907 when they caused a financial crisis back then and they were not allowed to be used until 2000, when [legislation] passed through Congress," said Miller, who added a peak estimate of their notional value was put at more than $62 trillion, or about four times U.S. GDP.

"They brought down a major insurance company, AIG, and yet the reform bill doesn't address this. To me, you need to outlaw credit default swaps or make sure that you have an insurable interest in the company. They're just allowing them for speculation. So much money is being made today by the big banks in trading credit default swaps. If you look at the income statements at the major banks, they are not making money making loans, by taking in deposits and loaning that money out," he said.

Miller also warned the audience about gold trading, which he maintained doesn't make economic sense because the price of gold has gone up so much faster than inflation. "Chances are at some point the bubble is going to break and you'll see it revert more back toward inflation," he said.

During his observations about the U.S. economy, Miller noted consumer confidence remains low and most people are continuing to pay down debt, in spite of low interest rates. "We've gone to over 14 percent of disposable income being used to service debt down to 11.5 percent. For the first time in certain markets, he's found inelastic demand for certificates of deposit, even when rates are lowered. Also, this is the first time that their banks sometimes have had to turn down deposits because of a lack of loan demand. "it is a real problem. I have never seen anything like it. It's a unique environment that we are operating in," Miller said.

Consumers have a period to go before they will be willing to take on new home mortgage debt, he said. "With less than 85 percent of the workforce working full time, consumers are still saving. Not what you'd expecting in a normal recession, but again but this not a normal recession," he said. Miller suggested that the Fed should consider raising interest rates by perhaps 1 percent, an increase that wouldn't kill the economy but would help consumers save more faster and shorten the period of deleveraging.

Athough some might view it negatively, Miller said, he thinks one small positive sign is that consumers are starting to increase credit card and consumer debt. "If they are willing to do that, maybe the next step would be mortgage debt," Miller said.

The SRI in the Rockies conference, which began yesterday, is in its 22nd year and attracts financial advisors, investors and businesses from around the world who are interested in sustainable, responsible investing.

--Dorothy Hinchcliff