The folks at Seeking Alpha asked me to give them some thoughts on what 2010 might look like for investors. In all deference to that Chinese proverb, these have been interesting times and are likely to remain interesting a little while longer.
In a similar article about what 2009 might look like, I opined that we would be in for a massive rally. That article drew 100 comments, which is by far the most for any post or article I’ve ever written. The general tone of those comments was to call me an idiot for thinking a 30-35% rally could be in the offing. Part of the logic there was that often after big scary declines that threaten the future of civilization as we know it, there is an enormous rally. The Dow Jones Industrial Average went up about 75% over one stretch in the early 1930s, so while I could have been totally wrong, of course, I was not calling for something without precedent.
While that call was not totally wrong, it most certainly was not totally right either. I did not think that the S&P 500 would go so low and I did not expect the rally to go up 60% (with maybe more to come?). I would say that getting the direction right is more important than getting the magnitude correct. If someone is worried about a large decline and reduces their exposure, does it matter if the decline is then 30% or 60%? Maybe some, but not as much as the decision to reduce exposure.
Now for 2010. In trying to figure out what might happen, I think some understanding of how markets tend to work is very useful. While the details of this event have been different, the emotions and behaviors expressed by market participants are not different. With eight trading days left in 2009, the S&P 500 is up 22%, which is very good. Unfortunately, since 1950 the market has only been up 20% or more for a second year in a row five times. Those five were 1955, 1996, 1997, 1998 and 1999 (actually only 19.5% in 1999). Many of the biggest up years, like 2009, are a snap-back from the previous year.
Certainly those numbers do not preclude 2010 being a huge up year, but they do show that buying power is rarely sustained into a second year. Once some sort of historical context is built, some kind of fundamental assessment is in order.
As John Mauldin has pointed out in his writings, the US economy will need to create 250,000 jobs every month for several years in a row to have a chance of getting the unemployment rate back down to 5%. Mauldin's thinking is that we need to replace the jobs lost plus keep up with the growth in the population. With the current path of debt issuance the US is holding, Ben Bernanke said that in a few years all of the US budget will go to paying interest. The US needs to issue more than $1 trillion in debt per year over the next few years, with the hope that with interest rates at all time lows, there will still be foreign buyers for this debt. Housing may or may not be showing signs of stabilizing, there is another wave of mortgage resets in the offing, and that is only a partial list of the problems that have to be dealt with.
Historical data and current economic events can be spun to make any case. I believe the easiest answer is that the US continues on its path of being a less attractive investment destination than other parts of the world. In the December 21 issue of Barron’s, they asked 12 market strategists for their predictions for the S&P 500 for 2010. All 12 called for an up year, with estimates ranging from 1120 to 1350 with the average being 1238. Going against this grain is usually productive in trying to assess what might happen. Beyond this poll it seems more people expect an up year than a down year. The conclusion I draw from the fundamentals is negative; combining that with what seems like positive sentiment leads me to expect a slight decline for 2010. The reason to not expect a large decline is that the S&P 500 is still 29% below its closing high of 1565. I believe the market will be down about 10%; for a specific number I believe SPX 1000 to be it.
An important theme in 2010 will, in my opinion, continue to be country selection. Foreign investing via some EAFE Index proxy will likely not fare well as Japan and the Western European countries that dominate that index may be just as unattractive as the US. Over the last decade (numbers compiled by Bespoke Investment Group as of Dec 1, 2009), the S&P 500 is down 24%, the UK down 23%, Japan down 49% and Germany down 16%. At the same time, plenty of other countries are up. Denmark and Hong Kong were up 30% in the last decade, Canada up 39%, Australia up 51% and Israel up 109% (these countries are at the lower end of the positive countries on the table). I believe these numbers belie the fact that this theme is more of a slow moving tanker as opposed to a speed boat (to borrow someone else’s metaphor).
Broad based foreign indexes provide exposure to both good and bad countries. Success in the coming year, and more importantly the coming decade, will require investing at the country level.
I have been writing about and investing in the same countries for a while and I believe they can continue to do well. The countries I own for clients are Australia, China, Chile, Norway, Canada, Israel, Sweden, Switzerland, Brazil and one UK stock. I would not hesitate to add exposure for new clients to any of those countries right now. Other countries that could be of interest in the near future include Denmark, Egypt, Peru, Singapore and Vietnam.
It is possible that the bearish view of the US will turn out to be wrong but that does not change the fact that many foreign countries are on firmer economic footing than the US, and so if US equities do well again in 2010, many foreign markets (excluding Japan and big countries in Western Europe) should do better.