This year will be unlike any other the world has ever known. Why? Because the myriad variables have never been arrayed exactly like this before and are unlikely to be arrayed like this ever again. The simple passage of last year will render impossible many of the other possible scenarios and create at least as many possible new scenarios for this year. Isn’t that wonderful? (Not exactly helpful, but wonderful none the less.)
We must admit that most forecasting is just observing trends and extrapolating them. It is the changes in the trends, the stopping of trends and the emergence of new trends that are hard to spot but so immeasurably more important. No one saw the devolution of the mortgage-backed bond industry in time to prevent it. Had they sounded the alarm none of us would have listened anyway. The few that profited from the insight that this market was due for a major shift still didn’t see all the ramifications that the shift would create. Yes, some folks sold short many billions in mortgage-backed bonds, but had they sold short shares of Fannie Mae, Freddie Mac, MBIA, AMBAC, AIG, Bank of America, Citigroup, Wachovia, Lehman, WAMU, etc., etc., etc., they’d have been far richer.
The next big trend will be much the same. As we’ve mentioned before, if you go out looking for gold, that’s about all you’re likely to find. Unless you’re looking for uranium, you’re not going to find it. So, what are the likely areas where the next big trend is going to emerge? (Uranium?) Your guess is likely better than ours. Please, send in any unreasonable ideas to your punditry team at your convenience, we need all the help we can get. Note that we asked for unreasonable ideas, the reasonable ones have already been discounted by the market.
One of the things your pundit is rather infamous for is throwing cold water on most new concepts; even the more attractive ones that most people wished would come to fruition. The reason we do this is because few of them ever actually make any material change in anything. The big changes are almost always surprises to most people and totally unforeseen. If they were foreseeable, they’d have already happened.
So, having proven that forecasting if both futile and pointless, let’s get on with it.
This year will not be like last year. In stocks, we will not likely start with a 25% collapse and then proceed with a 60% charge. The odds favor this year being more mundane. We are likely to gain quite a bit, enough to be happy with, say 20%. If we are wrong, it is because we are too timid, not too bold. The reason for the gain is simple, earnings will go up and fear will go down. Between the two, we could be in for a real good year, not a great year, but a really good year. The last element that could go terribly right would be a shift back into stocks by cash on the sidelines as it chases the higher returns available anywhere else. That might give us a great year, but we’d rather have a several good years than one great one.
Bonds will do a lot worse than last year because interest rates are going to start going up. Actually, this is a trend that is well established but not widely acknowledged. The low interest rate for this cycle was below 2% for the ten-year Treasury (set in early December 2008) and about 2.6% for the thirty-year at about the same time. We’re already up to 3.8% on tens and 4.6% on the thirties. But, we’ll probably go much higher before this is all done. It is the short-end that will see the biggest change, from zero to something is much bigger percentage-wise.
We will likely get some cushion from our investments in corporate bonds of either high grade or high yield. The same will probably hold true for a while on municipals and mortgages. The spreads that exist today can absorb some of the rise in rates as spreads narrow. But, that cushion will wear thin as this year progresses. There will probably be changes in the bond portfolio again this year. Be thankful someone actually looks at that periodically.
Foreign stocks should have about the same outlook in the developed markets, Europe and Japan are also struggling to shake-off the recession and establish viable recoveries. The more successful they are, the better their markets are likely to be. Given that they have a tailwind of more exports and less domestic consumption, they ought to do somewhat better. The emerging markets will be much more dramatic in the aggregate. There will be the usual mixed picture as some resource-oriented markets will likely do better while others don’t, but the average will be a lot better than the developed world, again. We doubt that the emerging markets can do 75% again this year, but 30% is a possibility.
Foreign bond markets should also outperform ours as they aren’t all facing the same higher rate headwinds. Europe will raise rates just like us, but Japan is not going to go there for quite a while yet. Many of the emerging markets will see their rates slowly erode as the risk premiums and inflation premiums there continue to shrink.
Real estate markets are a tough one to discern, so we won’t even try. After the powerful rally this year, we could be ahead of ourselves, or maybe we’re about where we belong.
Commodities are a little easier but not by much. If the world is going to have a few years of growth, we will consume more commodities of all kinds. Commodities will still have all the cross-currents that usually plague this area. Precious metals are probably going to slip as the safe-haven trade comes off. Oil could do very well as demand recovers. Industrial metals have rallied powerfully but might still have room to advance. Agricultural commodities will have stronger demand to support them.
Simple, most of the portfolio will work-out just fine. We’re cautiously optimistic as most of Wall Street paints it.
Case-Shiller home prices were unchanged in October from September. This was something of a surprise as most forecasters had expected home prices to continue inching up with the trend since about May. Maybe that was a little unreasonable given the number of other indicators that say the housing sector is still mired in an excess inventory situation with more foreclosures coming in months ahead. Also, this is a seasonally slow time of the year for home sales. A related item in the Wall Street Journal argues that high-end homes are having a more difficult time selling than most. The overhang of mini-mansions will take a long time to work itself out as buyer’s tastes have shifted toward smaller homes with lower upkeep and a lower price point.
Consumer confidence rose in early December from November, though not as much as most forecasters had expected. Even a little improvement was better than none. The 52.9 reading was a marked improvement over the revised 50.6 number from November. But, these numbers are still far below the 100 level that marks the starting point for this survey.
Going out with a whimper seems strangely appropriate for 2009. A sudden flourish at the end might have made us all feel better, but that isn’t what the market usually does. It is interesting that just as bullishness reached 2009 highs (still not really high but the highest we’ve been in quite a while) the market sort of swoons. The Santa Claus rally petered out last week and we got a largely directionless affair with low volume and some interesting twists.
Last Monday was our first chance to react to the Christmas Day underwear terrorist. And, the market largely ignored the new threat of exploding underwear. The government was all alarmed, but then what else have they got to do? Of course, there are still a few areas of our lives they don’t intrude in! There was only serious selling on New Year’s Eve, probably a single hedge fund that was making a bearish short-term play and took the entire market along for the ride.
We are facing another earnings cycle right in the face. This one is important as it will set the stage for 2010 earnings. We suspect that we will again get a lot more earnings than are now expected and that will convince at least a few analysts that they should revise their earnings view a little higher. We recall that in the last bull market, analyst earnings estimates trailed reality for almost three years coming out of the bottom of that cycle. We are probably experiencing the same phenomenon again. When the guesses catch up with reality, we should note that. If we do not, please remind us.
Stocks fell about 1% in the US last week, but gained in most other parts of the globe. The foreign indexes were higher, especially those for the emerging markets.
Bond markets tended to lower last week but in the US the high yield area eked-out again. Also, emerging market debt was generally positive for the week.
Real estate was lower, following the financial sector down. For the year, US real estate gained about 21% (the usual deep drop early and heroic rise later) but foreign real estate gained more like 40%. Our global stance helped with a gain of about 33%.
The commodity markets were strong last week with energy providing the spark. Gold slipped for the week.
Thank goodness that 2009 is over. We can put that one in the record books and look forward to 2010. The long shadow of the 2007-2009 bear market will probably stick with us for a while yet, but recede from unrelenting bearishness and constant skittishness to acceptance and then indifference. We suspect that 2010 will be another good year for the markets simply because of that receding bearishness.
Karl Schroeder, RFC
Investment Advisor Representative
Schroeder Financial Services, Inc.