Coming into 2009, the major themes we were looking at included a recovery in the U.S. stock market, a low interest rate environment, and an end to the recession. Now that checkmarks have been placed next to each of these prognostications, the question becomes: What will 2010 look like and what are the best investment strategies to employ going into the New Year?

While predicting that both the longest recession since the Great Depression and the worst bear market in a generation would end in 2009 was logical and not terribly far reaching, looking ahead to 2010 is definitely a bit more challenging. But, since having a theme to work from is important in the investing biz, we’ll go ahead and take a stab at it.

It’s the Economy…

Based on what we’re seeing in the data lately, it is safe to say that the outlook for the economy in 2010 is a bit of a question mark. The bulls argue that the rebound is underway and while the recovery will be rocky, we can expect to see growth continue throughout 2010. Our heroes in horns point to a low interest rate environment throughout the year, ongoing benefits from stimulus spending, increasingly better earnings, and a global rebound.

Yet on the other side of the aisle, our furry friends argue the following: (1) the consumer has made a generational shift in their spending patterns and now wants to avoid debt at all costs, (2) small business, which is traditionally the driver of job growth, is in a sorry state due to increasing tightness in lending, (3) the jobs market is unlikely to improve any time soon, (4) the stimulus spending will dry up in 2010, (5) the dollar’s slide is likely to continue, (6) increasing taxes and massive spending in Washington could present headwinds to the economy, and (7) the Fed will be forced to start exiting the party and raising interest rates. To hear the bears tell it; all of the above will lead to a weak economy on a best-case scenario and a double-dip recession if one chooses to look at things from the glass-is-half-empty perspective.

In looking at investment strategies from an economic standpoint, it is important to understand the relationship between the economy and the stock market. The joke is that the stock market has predicted 12 of the last 6 recessions. Thus, the argument economists like to make is that the stock market is a lousy predictor of the economy. And yet, it is interesting to note that the majority of economists have failed to predict any of the last 6 recessions. So, gun to the head, it looks like the stock market is the better predictor of economic cycles.

The next question is: Does the stock market lead the economy or vice versa? While this topic is often hotly debated, we’re of the mind that the stock market leads and then looks for confirmation. The market action in 2009 was a perfect example of this.

Stocks bottomed on March 9th and then began to rebound after Jamie Dimon told us that his bank was making money during the first quarter. With the failure of the banking industry suddenly off the table, the stock market began to remove the Financial Armageddon discount. From there, the market went on to discount the end of the recession and is now working on the issue of the strength of the recovery.

From where we sit, we would expect the market to continue to look for confirmation that its record-breaking rally has “gotten it right” in terms of predicting a rebound in the economy. Therefore, it is safe to say that utilizing a flexible approach in your investment scheme in 2010 makes a lot of sense.

In short, we don’t think this will be a year where you set up a strategy and then buy and hold. No, we feel that there are risks – big risks – out there, and that investors will need to have the ability to “go both ways” if things don’t work out as one’s crystal ball predicted.

Other Themes Worth Recognizing

While we believe that the state of the economy will be a driving force – especially early in the year – there are other themes that we feel are worth paying attention to in 2010.

Secular Bear in the Buck: We believe that the U.S. dollar remains in a secular bear market. This is not to say that the greenback will plunge from here. After all it has lost more than 15% since the stock market bottomed in March. However, the fundamentals for the dollar are not exactly positive at the present time.

For example, the Fed has pledged to keep rates low for “an extended period.” While this is a necessary evil in terms of keeping the banking system afloat (remember, those toxic assets are still out there and the Fed’s “borrow at 0%” plan allows the banks time to earn their way out of their capital problems), keeping rates low should continue to keep pressure on the dollar.

Benefactors from a weak dollar include commodities, commodity-based currencies, the emerging markets (especially Latin America and China), large-cap stocks in the U.S., and growth stocks in the U.S. We should point out that this theme is NOT new at this stage of the game and that corrections will occur. But, unless there is a reason for either a return of the “fear trade” (traders flocking to the dollar as a safe haven) or the unwinding of the dollar-carry trade, we’ll stick with the this theme for a while longer.

In sum, while the dollar can certainly rally at any time and for any reason (pay particular attention to anything causing the dollar-carry-trade to begin to unwind), we believe that we should go into 2010 with a game plan to buy the dips of the weak-dollar benefactors.

Chinese Demand: Recently, Zhang Ping, who is China’s chairman of the National Development and Reform Commission, voiced concerns about the country’s growth rate and expressed worry that China has an overcapacity problem. In light of the fact that China is clearly the world leader in terms of economic growth, these statements caused quite a stir.

However, the key from a big-picture standpoint is China’s current growth rate and its need for future growth (to avoid civil unrest) creates demand for commodities of all colors, shapes, and sizes. Thus, the secular bull market in China and the commodities it requires, is an important theme for investors to stay hitched to from a macro perspective.

Corrections Will Be Part of the Game: Finally, we need to go into 2010 realizing that the bulls’ recent for the roses, where the S&P has romped +64% in just a little over eight months, has probably seen its best days. The key takeaway is that although we do expect the bull market to continue, the recent rate of ascent will almost undoubtedly slow and we will likely see more meaningful corrections along the way.

History shows that during the first phase of what we like to call a “mini bull market,” corrections are short and shallow, with pullbacks rarely exceeding -5%. However, during the second half of these “mini bulls,” corrections tend to be both deeper and longer in duration.

So, given that the economic picture is murky and that stocks have run a long way in a short period of time, we’d like to point out: (1) the “easy” money has been made in this cycle, (2) buy and hold remains a bad idea in this environment, (3) the next “big move” in the stock market just might be down, and (4) if you don’t have a plan for playing defense in your portfolio, you’ll need to find one.

The last statement is not meant to scare investors. The point is we believe strongly that we are in a buy-and-sell market and NOT a market that will reward a buy-and-hope approach.

My Game Plan for 2010

I have recently made some changes to my personal account holdings. And while this should NOT be construed as a recommendation in any way, shape, or form, I would like to share the thought process behind my game plan going into next year.

In short, I want to be able to incorporate investment strategies that have the ability to profit from just about anything Ms. Market throws at me next year. To be sure, I do NOT have a crystal ball and as Marty Zweig once said, “those relying on a crystal ball will wind up with an awful lot of crushed glass in their portfolios.” But, at the same time, if we can identify potential themes within the current market, it will make it easier to stay in tune with the environment as the year unfolds.

Cutting to the chase, I have decided that I want to incorporate a “market timing” strategy, a flexible global strategy, and a flexible, concentrated equity strategy in my personal portfolio for next year.

The idea behind incorporating a market timing strategy is simple. Since I think we will see an up-and-down market for quite some time and that the risks of another bear market will rise as time goes by, I want to be have the opportunity to try and make money in both rising and falling market cycles next year. For me, this means using the Daily Decision.

I also want to have the ability to “go where the growth is” in terms of global markets with a portion of my portfolio. Currently the emerging markets are the place to be and I want to have exposure to these leading areas. But, I also want the flexibility to keep up with changes in the leadership. So, as you might suspect, I believe that being flexible and “going global” will be important in 2010. For me, this means using the FlexPro Portfolio.

Finally, while my stock selection strategy of buying the top rated stocks in terms of earnings strength and company/industry performance was not a big market-beater in 2009 (this year was all about “mean reversion” where the GE’s (GE) of the world gained 250%), it is important to recognize that ALL selection strategies underperform in certain environments. So, with a flexible approach and a strategy that has, in my humble opinion, performed well in the past, I’m going to continue to allocate a portion of my portfolio to stocks. At TSP, I use the Top 5 Portfolio.

So there you have it. While we are still working on refining our themes for next year, now is the time to start planning for “the turn” (of the calendar). If you are looking for an easy-to-follow version of my strategy check out the Dave M Portfolio. It is my sincere hope that this piece is helpful to you in plotting your strategy for next year.

Enjoy your weekend,

David D. Moenning
Founder TopStockPortfolios.com

Positions in Stocks Mentioned: None

 

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