Analysis from AdvisorAnalyst.com

Outlook 2010: Predictions and Surprises (Part 2)

The beginning of the year is a time for reflection and planning, and, like clockwork, to help us with investment planning for the year ahead. It's a time when some of the most notable prognosticators share their learned guidance as to what may be in store for markets. This year's selections are an eclectic mix of themes, both consensus and contrarian, deflationary and inflationary, and in some cases, are confusing and possibly surprising.

Byron Wien, Blackstone Advisory's new vice-Chairman, has just released his much heralded annual "Ten Surprises" list for 2010.

The U.S. Economy prints real gross domestic production growth at 5%, unemployment drops below 9%, and S&P 500 earnings come in above $80 (U.S.). The S&P 500 rallies in the first half of 2010, then declines to 1,000 pts, ending where it started the year, as rising interest rates and full valuations are threatened by concerns of over-indebtedness and sustainability of economic growth.

Foreign reluctance to keep buying notes drives up 10-year Treasury yields to 5.5%, but bank lending improves as banks reduce their dependence on the carry trade. Wien also predicts that Iran's Ahmedinejab will be unseated in favour of a more "PR" adept leader, reducing geo-political concerns, and putting Pakistan back in the hot seat.

Japan will outperform the world's industrialized markets, owing to a cheaper yen and attractive valuations which now stand at one-quarter of their 1989 highs - the Nikkei rises to 12,000 pts. during the year.

It's worth mentioning that, with a few very minor exceptions, Wien's 2009 predictions were bang-on.

In his 20 Surprises for 2010, Doug Kass of Seabreeze Partners, says the dollar rally could "explode" higher, first quarter earnings reports could surprise by as much as 100% year-over-year, U.S. stocks could drop by 10% during the first half, and the price of gold could topple to $900. His geo-political call is that Middle East peace is "upended" as Israel attacks Iran.

Kass also predicts that second quarter U.S. GDP growth flattens, as central banks tighten sooner than expected, and housing and jobs fail to revive. It is a comprehensive list, and a stimulating read.

Back in December, before the holidays, David Rosenberg, chief strategist at Gluskin Sheff, urged investors "to maintain defensive strategies and minimize volatility and downside risks as well as to focus on where the secular fundamentals are positive, such as in fixed-income and in equity sectors that lever off the commodity sector."

Rosenberg says, "This, in turn, underscores my primary focus of favouring Canadian dollar based investments over the U.S. because at no time in my professional life have the downside risks – economic, fiscal, financial and political – been so low on a relative basis and the upside potential so high as is the case today," He added, "Northern exposure never felt this hot."

On the emerging markets front, Goldman Sachs Group Inc. chief economist Jim O'Neill, said he favours Russian stocks among the so-called BRIC (Brazil, Russia, India, China) nations because of lower interest rates and higher oil prices.

"Russia's fundamentals look best in terms of the market because the central bank is not going to be tightening monetary policy any time soon," O'Neill said today in an interview on Bloomberg Television. "With oil prices very strong the combination is very favorable."

In a recent interview on CNBC, noted UK technical strategist, Robin Griffiths of Casenove Capital, suggests that India is a safer bet than China.

"China is heavily dependent on exports for its economic growth and so is linked to the strength of Western economies," Griffiths points out. Any economic slump in the West will dent growth in China, he said.

"That is considerably less the case in India, (which) doesn't really import or export anything very much. It's just got to slowly grow its own economy by building up its infrastructure, which I think will keep driving the secular or very long-term trend higher," Griffiths said. "This is one of the safer Asian markets to be a long-term investor in," he said taking a technical look at the Sensex Index."

I tend towards a wholistic view after digesting all of this – basically, the dollar is strengthening, and that will be due to a combination of factors such as short covering, deleveraging, and possibly a return to risk aversion, though few forecasters are putting it that way. Commodity-weighted economies such as Russia and Brazil, among the emerging markets, and Canada among the G7 are favoured. In terms of economic and financial stability, Canada, among the G7, and India, among emerging markets, have both gained favour among global investors for their strong banking systems and sound fiscal policies.

Among the contrarian bets, Japan has gained some supporters, as its currency weakens (the yen is replacing the dollar as global carry trade's primary funding currency), and its exports improve, and deflation's supporters believe that fixed income will gain from historically strong demand for bonds. I would re-iterate that we have Japan's deflation misfortune to thank for the reversal of the nine month trend that saw equities recovering on an ever declining dollar. By the way, the above forecasts would have been profoundly different had the Bank of Japan not moved to ease when it did, but that's for another instalment.