January 2010 Current Thinking January 8, 2010
From a stock market perspective, it will not take much to make 2010 better than 2009, so let us enjoy some New Year's cheer! By the way, the economy shed 85,000 jobs per Friday's employment report. But one month’s employment does not a year make. So how will the year turn out: what can we as advisors and investors expect? Here's JDM's take on it:
1. Ten year US Treasury bond yield ends 2010 at 4.5%, a salient point for our
2. S&P 500 ends the year at 1655 – keeping in mind, it closed at 1141 at end
3. The US dollar stays in a tight trading range with the rest of the developed
world – we will use the Euro as our benchmark – so $1.38 to $1.48 versus
4. Oil flirts with $100/barrel but does not break it.
5. Inflation is only a minor irritant – running at less than 2%.
Okay, okay, being so precise is almost a guarantee of failure, but we really think that 2010 will be a great year for our clients. From an equity point of view, from March of 2009 to the end of 2009, our equity markets enjoyed a nice bounce off of the lows – and, yes, it was painful hitting those lows – but back we have come. Our optimism comes from several fronts. First and foremost are the interest rate levels in our country, which most certainly have contributed to our economic stimulus. The interest rate on ten year Treasuries is something to consider – as of yesterday, it was 3.82%. Two year Treasuries closed at 0.95% - a spread of 2.87% or 287 basis points. This is known as a “steep positively sloped yield curve.” Banks feast on these, even though they sound like a snow skier's worst nightmare! But back to the banks. They can borrow cheaply and lend dearly, i.e. make a lot of money. And, yes, those same banks are starting to lend. The slope and steepness of the yield curve has generally been a viable predictor of economic activity, and, right now, it is giving us a very positive signal.
Secondly, we have seen some very positive earnings growth in the S&P 500 companies. 2008 earnings for the S&P 500 companies came in at $65.47 per share (Standard & Poors Research) with 2009 expectations in the range of $55 to $63 per share. 2010 is expected to be in the $74 to $78 range. Earnings drive stock prices – here come the earnings. It is the lower interest rates and cheap dollar that are making a lot of this possible – nothing like a little export-driven consumption to help drive earnings. As an example, look at how Caterpillar (NYSE:CAT) has benefited from this.
Finally, there are other tea leaves that can be read via historical signposts to give us cheer. On the historical front, the third year of nearly all presidential terms generally coincides with a very good year for the stock market (Trader’s Almanac). It does not matter who the President is – 80% of the time we have a positive return for equities. And predictors show that a good year in year three means year one was not so good, and year four may mirror the early one. In President Obama’s case, year one probably could not have gotten any worse – shy of a complete economic meltdown, ala Iceland. But year two was better, thus setting the stage for 2010.
The other tea leaf is the consensus of all the other forecasts out there by the major Wall Street Firms – yes, there are a few left. We have learned that consensus forecasts are usually wrong. Think of a bell-shaped curve – one like you were tortured with in statistics class – with the consensus forecast in the middle or at the high point of the bell-shaped curve. What actually occurs in history is usually on one side or another of that high point. The consensus forecasts are calling for a pretty ho-hum year for the equity markets. So, if that is the case and "ho hum" is in the middle of the bell-shaped curve, could the returns be better than expected or worse than expected this year? Based on our reasoning in this letter and our "current thinking", we believe the returns will be better than expected, in fact, much better. We don’t think it will be any worse – we’ve already experienced that. And, again, given the stimulus and measures in place, mostly coming out of Washington no matter your politics, the economic pump has been primed for expansion.
So here is to a happy and prosperous New Year, snow enthusiasts and sun-lovers alike!
JDM Investment Counsel