At the beginning of each year, we like to run through the key components of the market in order to try and get a feel for what to expect in the New Year. We’re not so much trying to look into a crystal ball and make a bunch of predictions as we are attempting to identify where we are in the big-picture cycle. In short, if we know where we are and can identify where we could be going, the hope is that we might be better prepared for the inevitable roadblocks that tend to crop up along the course of any journey.
So, since we’ve got an awful lot of ground to cover, let’s get right to it.
Secular vs. Cyclical
The first key thing to recognize about 2010 is that we remain in the midst of a secular bear market. By now, I’m sure you’ve seen the statistics regarding the stock market’s “lost decade” where the S&P lost -24.12% for the ten-year period ending 12/31/09. But the numbers for the average investor may be much worse than that. According to our internal calculations, the Lipper Large Cap Growth Index (a proxy for the average large cap growth mutual fund) is down -35.76% since the beginning of the new millennium.
The reason we bring up these disappointing statistics again is to remind everyone that we believe stocks remain in a secular bear market (defined as an extended period of negative returns) that is now 10 years old. And unfortunately, if we use history as a guide, the current cycle could last a while longer yet as the last secular bear spanned the period from 1965 – 1982.
Thus, the second key thing to understand about the upcoming year is that the current run for the roses is likely to end or, at the very least, slow down. In other words, the easy money from this move has already been made. In addition, we believe we are likely to see more volatility and more risk than we’ve witnessed over the past nine months.
However, we are NOT saying that the current rally is over. On the contrary, we believe there is more upside ahead. As we have mentioned a time or twenty, we believe we are seeing a “mini bull” within the context of a secular bear. And based on history, this type of market advance usually lasts a year or two (640 days to be exact).
The bulls also have the “breadth surge buy signals” going for them. As we reviewed throughout the past year, the market is usually higher 12 months after we see a significant surge in breadth. And for the record, the latest breadth surge signal occurred in September.
Yet, given the extent of the current run, we believe that the bears are very likely to reassert themselves at some point during 2010. Thus, we believe it makes sense to go into the New Year looking for trouble and ready to play defense if needed.
Now let’s turn to what we believe will be the key drivers for 2010: the economy, the state of interest rates, corporate earnings, valuations, and the risks to the system.
It’s The Economy, Stupid…
Given the question marks that exist regarding the state of the economy, we believe the stock market will continue to take its cues from the economic data in 2010, especially during the first half of the year. Good data should lead to (but doesn’t guarantee) higher stock prices. We’ll get to the exceptions to this concept in a minute, but from a big-picture standpoint, economic reports that come in better than expected should continue to embolden the bulls.
We would expect to see the economy continue to improve in the early going, but then begin to stagnate as the year wears on as the headwinds begin to take their toll. For example, we need to recognize that the economic stimulus that was applied in order to pull the economy out of its death spiral will expire, and that given the country’s growing concern about the massive deficits being run up, we’re not so sure Congress will be able to toss around another trillion dollars in 2010.
Some of the headwinds blowing in the face of economic growth include higher taxes that are scheduled to kick in during 2010, rising interest rates, an anti-business mentality among Congressional leaders, and a generational change in consumer behavior.
Reviewing briefly; higher taxes for businesses mean less incentive to grow a business, hire employees, and spend.
