Good Evening: U.S. stocks ended this holiday-shortened week with yet another rally today, leaving both the Dow and the S&P 500 perched at new, post-crash highs. In fact, equities have been on quite a tear since the early February lows set when the world fretted about whether the EU would be able to extinguish the Greece fire burning on its southern flank. Worries about tighter monetary policy in China and the imminent end to Quantitative Easing by the Fed were also contributing factors during the winter sell off, but all these fears seem to have receded in recent weeks. Even a trillion dollar increase in U.S. healthcare spending couldn’t prevent the sun from continuing to rise in the East each morning, and investors have resumed chasing their favorite names now that the first quarter has given way to the second without the world coming to an end. With all the positive momentum on display in our markets, it dawned upon me this morning that perhaps it would be wise to revise my 2010 forecasts.
Like most economic data released this year, today’s slate of statistics indicated firmness in the manufacturing sector of our economy. Yes, auto sales are still weak and housing has suffered what looks like a relapse, but most indicators here and abroad have been coming in on the sunny side of expectations. Equity market participants have responded by giving our economy and their buy orders the benefit over any lingering doubt. Perhaps the factor that has given investors as much confidence as any other is the repeated assurance in recent days by various Fed Governors that a tighter monetary policy stance may be postponed until 2011 rolls around.
With global stock prices nicely in the green overnight, U.S. stock index futures were indicating a rally of 0.5% prior to this morning’s open. The major averages wasted little time in advancing a full 1% once the bell actually rang, but those levels couldn’t hold. A poor quarterly earnings announcement by RIMM last night may have played a role in checking investor risk appetites, but it is more likely that many just wanted to take some chips off the table ahead of tomorrow’s unemployment report. The indexes retreated until they nearly reached the unchanged mark, though some, (e.g. the NASDAQ) actually went negative for a spell. A closing flourish to the upside left the averages with gains of between 0.2% (NASDAQ) and 0.8% (Russell 2000). Treasurys declined again, with yields rising between 2 and 5 bps across the coupon curve. Higher interest rates probably won’t garner the attention of stock market investors until the 10 year note sports a “4 handle” (vs. 3.87% today). The dollar index fell 0.44%, and commodities reacted by rising. With crude oil touching $85/bbl. and the precious metals springing back to life, the CRB index gained 1.1% today.
The rising stock market has forced me to face a new reality. I’ve decided to embrace the school of momentum investing, since price obviously matters more than value these days. Furthermore, I’m going to now side with those who claim gold is a runaway bubble and that the barbarous relic should be best put to use as paperweights on one’s desk or ballast in one’s yacht. Since I’m shucking my dark sunglasses for a pair with a rosier tint, below please find the revisions to the forecasts I made during the first week in January.
2010 Outlook: (Revisions are post-hyphen)
U.S. Economy: Fed will keep short rates near zero, so recovery continues early in year. Risk of GDP slipping back toward zero increases as year progresses, but any “double dip” recession may be a 2011 story — when higher tax rates take effect. Even if the U.S. economy displays surprising strength in the first half of ’10, the resulting increase in long term interest rates should forestall that growth later this year.
— The U.S. economy will just keep getting better. Neither inflation nor deflation will prevail, so don’t worry, be happy.
Stocks: Trade in a wide but uneasy range. Upper end for S&P should be 1200 to 1300, while lower end should be 950 to 850. Stock picking (alpha) will be more important to returns than getting the market trend right (beta). I still prefer low-debt, high dividend paying stocks (e.g. Big Pharma), as well as companies with rising cash flows that give managements financial flexibility (with some exceptions, higher quality names do not appear to trade at high premiums to lower quality companies). I also like having exposure to what Nassim Taleb calls “positive black swans. Some of the best of these “spec plays” could be in small mining stocks (still decimated after ’08 rout), or in smaller biotechs with attractive pipelines (e.g. drug candidates beyond phase 2 — preferably beyond phase 3). Corrections of 5% to 10% can hit at any time (even in January), but either higher interest rates or higher tax rates on incomes (and capital gains!) loom as potential downside catalysts after spring. My own plan is to use rallies to take profits and/or establish hedges.
— Stocks will rise every month for the remainder of the year. Just go with the flow, because positive momentum is the best indicator around. “Buy and Hold” makes a comeback.
Bonds: Very tough environment in 2010 and bonds deserve a minimal asset allocation for now. At these levels, Treasury investors need either geopolitical turmoil or a relapse in the economy. Since either of these outcomes will only add to the massive issuance needs of the U.S. and others in the G-8, use rallies to shorten duration and look for high quality among corporates, senior bank loans, and municipal bonds issued by well funded locales. True credit analysis will continue to be of value, since nimble active management should outperform lumbering mutual funds.
— They may not be exciting, but Treasurys are “super-safe” and they yield more than trashy cash.
Dollar: Should weaken, but it could see intermittent rallies due to sovereign debit concerns (think: Europe), or increased geopolitical conflict (think: Iran ). Better than 50/50 chance the U.S. Dollar Index sets a new, all-time low in 2010. Favorite G-8 currency is the Canadian loon and favorite emerging market currency is Brazilian real, but the REAL question is how long can the imbalances of the dollar-centric, global fiat currency regime last?
— The dollar has rallied for most of 2010 and is quite fashionable now. Stay with King Dollar; it’s a great carry-trade vehicle!
Commodities & Precious metals: I am still long term friendly towards commodities as a store of value, but components of the CRB index should be volatile in ’10. Energy and base metals might outperform early in year, but agricultural commodities should outperform as the year progresses. Gold will be volatile, but I think the barbarous relic will set another all time high this year. Responsible central banking (i.e. rising real interest rates) and fiscal discipline by sovereign governments represent the biggest long term threats to commodities, while “anti-speculation” legislation is a nearer term risk. The potential headwinds created by either monetary or fiscal discipline, however, are much less likely to materialize than the potential tailwind of currency volatility.
— Who cares? Precious metals are useless and the CRB index has been stuck in narrow range, so just forget them.
U.S. Housing Market: Subsidies, a Fed on hold for now, and various private capital solutions for upside-down borrowers will help U.S. housing during the first half of the year. Housing will flatten out or even suffer a relapse later this year as these tailwinds subside and long term interest rates start to rise.
— The Case-Shiller index is about to turn positive year over year, so use those carry-trade levered dollars to buy huge homes or even flip condos.
The Fed: Stays “All In” by keeping short term rates on hold for most of 2010. Threats by the Fed to tighten monetary policy will be idle ones unless economic growth and job growth really surprise to the upside. Should the economy slip back, expect renewed Quantitative Easing. Mr. Bernanke seems willing to risk a funding crisis down the road in order to prevent a repeat of what he has said were policy errors by the Fed in the 1930’s (i.e. they tightened too soon)
— The Fed is in complete control, and the guys & gals on the FOMC will always pick the right interest rate. With Chairman Bernanke’s steady hand on the helm, we can expect strong growth and stable prices for an extended period.
Volatility: More subdued in 2010 than in past two years and should range between roughly 15/20 and 35/40 for the VIX. Geopolitical turmoil, or a disorderly fall in the U.S. dollar, are the biggest risks to the upper end of this range.
— The Fed will succeed in all but banishing this bane of investing. The VIX is headed to 10.
Credit Spreads: Credit spreads still offer value, but not nearly as much as at this time last year. Solid credit analysis will expose relative value opportunities, but at least some profits should be taken if spreads continue to compress. Volatility caused by higher long term interest rates or disorderly currency conditions could present better investment opportunities.
— Don’t play games in this sector, just reach for the most yield you can find and enjoy both the coupons and the capital appreciation that are surely coming your way.
Inflation: CPI is not a worry during the early months of 2010, but it could become one later this year or in 2011 if the near zero fed funds rate overstays its welcome. Cost-push inflation (i.e. rising food and energy prices) is much more likely than demand-pull (i.e. rising wages) inflation.
— The nirvana of true price stability is here! Please dump TIPS, gold, and any other investment beneficiaries of money-printing because they represent insurance you’ll never need. Remember, the Fed is in complete control of the situation.
Before you start thinking I’ve joined the Crocodile Dundee school of forecasting (“No worries, mate”), please consult your calendar. Happy April Fool’s Day and have a great long weekend, everyone.
— Jack McHugh
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