“What If” seems to be the best tag line I can come up with for our near term economic outlook. One fact I have humbly learned throughout my career is that the market is and will always be smarter than most of us. Over my 25 years working with who I believe are some of the smartest and brightest money managers in the world, I do not remember hearing such a wide range of predictions for the next year. By listening to our clients, I’ve learned of even more predictions for this year’s outlook. Both clients and money managers helped me coin our theme for 2010.
WrapManager’s Themes For 2010
The themes fall into four different camps: “Inflation Is Coming,“ “V-Shaped Recovery,“ “Slow But Growing,“ and the “Double Dippers.“ I am sure there are others but these seem to be the loudest and most popular themes for 2010. I feel that you will gravitate to at least one and maybe more of the themes after you have finished reading this report. At the end, I will share my humble predictions for 2010. This makes it fun, so let’s get started.
“Inflation Is Coming”
I imagine the inflation soothsayers on CNBC riding a horse shouting “Inflation is coming! Inflation is coming!” These modern day Paul Reveres believe the US government is printing too much money and the only outcome is near term inflation. They believe this expected inflation will be high, similar to what we experienced in the 1970s. They also believe that the US government will be forced to pay foreign governments higher interest rates in order to get them to buy our growing debt. However, many people in the “Inflation Is Coming” camp believe that higher inflation is the sneaky way our government plans to solve the housing problem. The theory is that inflation will cause housing prices to go up from these low levels or at least stabilize. Inflation will also give companies the opportunity to raise prices of their goods and services. As a result, this may entice employees to demand higher wages to help stay with the cost of living. Finally, additional income tax revenue will increase because of these higher wages. This cycle could indeed be one of the best outcomes for the disastrous housing crisis. However, there is a concern that things could get worse with inflation and higher interest rates, keeping the US economy in a bind with little or no improvement in employment or US gross domestic product. Basically, you need to invest your money in a way that keeps up with inflation and maintains its purchasing power. These investors want to be invested with money managers that focus on investments that preserve purchasing power.
“Double Dippers”
The “Double Dippers” believe the US and global economic activity will decline and turn negative again in 2010. The stimulus programs will run out of steam, the money pumped in will not sustain a growing economy, and unemployment will remain 8-11% for a much longer period of time. As a result, we will see increases in foreclosures, bankruptcy and credit card delinquencies. These financial strains will keep retail sales down and factory inventory levels lean. As you can see, the downward spiral will only grow and spin faster. The Double Dipper’s solutions out of this mess include another government stimulus package and other measures that allow more time for a natural recovery to begin. Hopefully, interest rates will remain low and people will begin spending within their means. Many of these investors are keeping investments short-term focused with money managers that have the ability to profit by moving in and out of the market.
“Slow But Growing”
This is the belief that growth will be positive but slow, below average, and continue for 3-5 years. Unemployment will start to improve but not by much. This is a slightly more positive outlook than the “Double Dippers.“ The “Slow But Growing” crowd expects low single digit rates of returns in the equity markets for years to come and feel interest rates will remain about the same or slightly higher. They expect money managers that are good stock pickers will be able to generate better returns than the market indices.
“V-Shaped Recovery”
A “V-Shaped Recovery” is one that goes up just as fast as it went down. Here’s how the “V-Shaped Recovery” theory plays out. Inventory levels are low and factories will need to increase output to replenish these low levels. Not doing so would leave companies with little to sell as buying picks up. People are feeling more job security and will start to spend more of their income and the money they saved over the past year. As a result, demand for goods will increase and factories will need to quickly hire more employees to keep up. These newly employed will start spending more, helping to fuel the expansion further. “V-Shaped” believers expect the Feds to raise rates later in the year, but in a controlled manner. Investors with cash on the sidelines who missed the rally will jump in the market and push it even higher. They do not view the government’s $1.2 trillion spending program as a big problem because it has only replaced a third of the $4 trillion the banks used to lend out. The “V-Shapers” also believe in the government’s Keynesian approach to spend our way out of this mess. The velocity of money changing hands will improve and Ben Bernanke will keep the economy steady. These investors like money managers with a history of excess performance in expanding economies.
I hope you can identify with at least one of the themes now that I’ve explained them. Based on the conversations with clients, some agree with one of the themes, while the majority agrees with a combination.
My Theme For 2010
I agree with a variation of the “Slow But Growing” camp. I believe we are in an environment with positive and sustainable corporate earnings growth. As of this writing, the majority of companies have reported better than expected 4th quarter 2009 earnings. Many companies themselves are guiding research analyst’s future earnings estimates higher, giving me more confidence in the numbers. Over the past 30 years, the S&P 500 has been trading in a range of 10 to 29 times earnings with the average being 18 times earnings. Estimated 2010 future earnings for the S&P 500 is $74, and $85 for 2011, with some even projecting $90 for 2012. Calculating this out using the 18 times multiplier for future earnings, we could see the S&P 500 somewhere between 1,300 and 1,550 over the next 18 to 30 months. We are also in a low interest rate environment with the Fed indicating low rates for an extended period of time. I believe this is very positive for future economic growth and stock appreciation.
Regarding inflationary fears—I am watching the inflation indicators and do not see any immediate concerns. Before inflation rears its head, I feel that unemployment will need to decline to around 6.5% from the current 10% level, and industrial utilization move higher from 70% to 85%. Inflation is simply too much money chasing too few of goods, and we are clearly not there. Fears of no one buying US government debt seem to be more fear than real. The last few Treasury auctions have had $3 of buyers for each $1 sold, and a large portion of these auctions are still being bought by foreign governments. I expect to see future gains in the US and global stock markets and low to slightly higher interest rates over the next two years. Personally, I would focus on the high dividend manager strategies and money managers that have a history of excess performance in rising earnings stock market environments.
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