The New Year greets no shortage of opinion about the markets. While a number of pundits are saying that stocks must eventually pull back from their impressive gains in 2009, others think that equities are poised to rise as corporate earnings recover. The corporate bond market's phoenix-like ascension last year has been met with similar debate. The lack of conviction on either side of the argument suggests that 2010 will provide significant rewards for opportunistic investors.
The U.S. equity market's overall direction may remain unclear, but it's not impossible to separate the winners from the losers. Consider the retail sector, which has suffered as consumers have increased their savings rate due to economic uncertainty. The difficulty in obtaining financing for inventory has been another shock to the system. Virtually all sectors of the retail market have suffered, but firms with a larger footprint will inevitably find the staying power to survive, and eventually thrive, in an environment with less competition.
This same logic can be applied to the market as a whole. In this era of tighter credit and more prudent spending, large U.S. corporations have significant advantages over their smaller counterparts. Investors will flock to these shares, especially those with sound dividends, while small-company stocks will remain relatively unloved. Wal-Mart (WMT), for example, still sports a relatively attractive dividend of 2.2%, and looks like a good long-term hold as it expands market share both here and abroad.
Worldwide economic growth will continue to be uneven. While emerging market economies and commodity-led countries enjoy garish expansion, developed countries will lag. Exposure to these markets is a prudent hedge against inflation. Further, many of these countries have better balance sheets and higher yields than U.S. bonds. As a result, the fixed income markets in these countries are particularly appealing, and have less downside than their corresponding equities.
With last year's investment gains being led by assets that had become too cheap, one may wonder if there are any bargains left. One dark horse to consider is Japan. Facing a host of economic and cultural problems, an aging workforce, and fading domestic consumption, 65% of Japan's companies are trading below book value. Nonetheless, the larger companies in Japan that are more export- than domestic-focused should do well. In my view, large-cap Japan represents a near-perfect combination of contrarian and value characteristics.
An economic view is not complete without a view on interest rates. In a nutshell, domestic rates are low and will stay that way until the economy becomes self-sustaining. That won't happen until later in 2010, at the earliest. Those anticipating a rate hike will eventually find their way hopping from bonds to stocks, a trend that will likely progress throughout the year.
All economic forecasts should come with caveats. Fortunately, our investments should do well even if our outlook is incorrect and an earnings rebound causes rates to rise much sooner than anticipated. That should make our recommendations more actionable, even to the most skeptical.
Contributing Editor Ben Warwick is CEO of Quantitative Equity Strategies in Denver, and CIO of Memphis-based Sovereign Wealth Management. He can be reached at ben@qesinvest.com.
