Economic and Market Outlook

This is the 2010 Outlook that Rob Rose and I wrote and sent to clients.

“Certainty is the mother of quiet and repose, and uncertainty the cause of variance and contentions.” – Edward Coke

I, as well as many of my esteemed resources, believe that the Market will continue its emotionally-led recovery on a course to return to levels just before the collapse of Lehman Brothers (around 11,500 Dow and about 1250 S&P 500). This probably will not be a straight run up and most likely will come with some headwinds that could slow the trajectory or change the direction completely, depending on the severity of the issue. In addition to the increasing potential for an act of terrorism coming to fruition, below we have detailed some of the primary issues that we will be watching for. These issues and the overall economic condition at the time of the attainment of pre-Lehman levels will determine where we go from there.

Political Influence: With the way this crisis has been handled – a focus on the government to fix things – the government will continue to be the primary area to watch. Since this is an election year and major policies will continually be discussed with more bravado than usual (i.e., health care, Social Security – this will eventually need to be discussed, international trade, wars, etc.), we should continue to see uncertainty in the markets and the economy. Historically, these mid-term elections have seen changes in political party dominance. Usually, this creates a type of gridlock in legislation that investors like (i.e., no major policy shifts can take place in a gridlock).

The Fed: I think that Riverfront Investment Group does a good job describing this area in their outlook for the year:

“The Fed’s current quantitative easing program is due to be completed in March. We think it will then face a difficult choice. The Fed can stop purchasing government bonds, there by risking higher long-term interest rates, dampening the housing market and potentially endangering economic recovery. Alternatively, it can extend quantitative easing and continue funding these purchases by printing more dollars, which would continue weakening the dollar and likely raise inflation expectations.”

“With government stimulus spending expected to peak in mid-2010, we do not believe that the Fed will risk derailing the economic recovery. Thus far, there has been little reason for concern over inflationary consequences of Fed policy. Headline CPI could approach 2.5% by mid-2010 and potentially higher if there are spikes in food and/or energy prices as we expect. However, the Fed is focused on core inflation (excluding food and energy) and projects that this inflation rate will remain in a comfortable 1.0% to 1.5% range.

Fed Chairman Bernanke’s writings on both the Great Depression and Japan’s more recent battles with deflation suggest that he views the primary policy risk to be withdrawing stimulus too quickly rather than applying too much. For these reasons, we believe that the Fed will not hesitate to extend the current quantitative easing program and keep buying bonds beyond its $1.7 trillion target, if deemed necessary. Extending the Fed’s reflationary policies would likely support financial markets, especially risk assets, and prompt renewed dollar weakness.”*

The Consumer: With unemployment expected to remain high, credit still not as easy to come by, and (as discussed previously) the possibility of continued housing difficulties, U.S. consumer spending is expected to be low this year. Many are calling this higher saving, lower spending consumer “The New Normal” (although the must-have gadgets appear to break the mold). This lower spending is expected to keep sales below pre-crisis highs. There are some possible bright spots in regard to global consumers; China showing the highest promise (though there are significant obstacles to overcome there). Sales in general will be very important to keep an eye on this year; not necessarily comparing them to pre-crisis years, but watching for growth quarter by quarter.

As I have mentioned before, I believe this year will have an emphasis on quality. However, as this theme seems to have finally caught on to the rest of Wall St., I would like to make sure my definition of quality is clearly stated. First off, I do not believe that in order to be quality the investment has to be a defensive position (typically thought of as those companies whose products or services maintain demand in a declining market). To me, a quality stock is one where the company’s fundamentals are in place (i.e., good management, strong balance sheet, good earnings – both current and forecast, etc.) and they are able to consistently grow their dividend. Why is this dividend growth such an important measure of quality? Because typically a company that can consistently raise its dividend is one that has the fundamentals in place. Also, in the past, dividend growers have outperformed over the long-term. Of course, dividends can decline or be removed completely by the company and are not guaranteed.

As always, your investments should be matched to your goals not necessarily the latest hot picks. Please let me know if you have any questions. I wish you and your loved ones a wonderful and profitable year!

*www.riverfrontig.com