Don’t Be Suckered By Stock Market Rally In 2010

Global stock markets are poised to end on a high for the year after mounting an explosive recovery since March lows. The stock market rally, nearly ten months in duration, has surprised many naysayers with its longevity and magnitude. Nevertheless, after such a run-up, some consolidation is in order.

Rampant bullishness in the stock market disappeared over the past weeks and is likely to remain so till the end of the year. Stocks in various sectors (ranging from financial, property, construction, oil and energy) remain range-bound and though major indices are creeping up, they are being led by fewer counters and on low volume.

Bulls vs bears battle may be evenly split right now but according to most analysts, the stock market rally going into the new year is alive and kicking. Their forecasts of 1250-1300 are realistic enough with the 50-day moving average of 1,085 holding firm and could provide a launch pad for breakout in the coming weeks.

However, whether the S&P 500 can hold its ground till the end of 2010 is another question altogether. If you have gone through the internet and housing bust, you will know that analysts reports must be read with a healthy dose of skepticism. And when most of them agree, alarm bells should start ringing.

As a buy-and-hold investor, there are much to worry about, but you should enjoy the rosy picture of improving economic conditions being painted in the short term. Confidence in a robust economic growth has underpinned the optimism in stock markets.

US economic indicators are mixed but certainly more encouraging than in March. Expansion in the manufacturing sector is slowing down but the Federal Reserve’s industrial production report showed a month-over-month increase.

Jobless claims fell by 28,000 last week to 452,000 – the lowest level since Sept 2008 before the implosion of Lehman Brothers sent financial markets into a tailspin. Barack Obama is still not happy with the unemployment rate though and has urged banks to lend more aggressively to small businesses.

I am not sure if that is a good call because 133 banks have failed so far by acting against their better judgment during the boom years. It is actually refreshing to see banks exercising prudence and shoring up their balance sheets. But even if all the redtapes are removed, many businesses are still wary about expanding production and increasing payrolls when consumption is still anemic.

If businesses or consumers are not taking advantage of cheap loans, you can rest assure that speculators are relishing the zero interest rates. Herein lies the crux of the problem, the cheap cost of capital is actually doing little in creating jobs and demand. It is a jobless economic recovery.

Where has the money flowed to? A good guess is Asia which has seen asset prices rising up without supporting fundamentals like increasing income or productivity. A case in point is China which has seen land auctions fetching record prices in Guangzhou and in Shanghai recently, despite concerted measures to cool the red-hot market.

To quell investors’ uncertainty, China has committed to another 8% GDP growth for the year 2010. If they mean what they say, banks will not pull the stops on lending but they will certainly have to raise core capital to buffer against the prospect of more bad loans. With the momentum carried over from 2009, this 8% target is achievable. However, the Chinese government should be mindful of over-heating and ensuring that its frothy assets do not follow in the footsteps of Dubai.

The Singapore government has also predicted GDP growth for 2010 between 3-5%, on the back of improvements to global economic conditions. Meanwhile, Thailand have joined Malaysia and South Korea in reporting a turnaround in exports as they posted the first export increase in 13 months.

Without a doubt, economies are on the mend. How could it not after massive stimulus programs and additional fiscal burdens bore by governments around the world? The Federal Reserve must take credit for creating a feeling of “prosperity” with their Quantitative Easing and zero rates policy.

In their year-end meeting, the Fed indicated that interest rates will not be raised for an extended period, so that fledgling growth in the economy is not jeopardized. Such “accommodative” circumstances means champagne will continue to flow at the party. Investors have little choice but to pour their money into stocks, commodities or properties because deposits offer paltry returns while money printing turns their cash into trash.

Indeed, I believe stock markets may keep on rising in the short term. You can announce all the bad news right now and investors will not bat an eyelid. However, when market sentiment turns around, good news may be interpreted badly – whether the glass is half full or half empty is up to the analysts or big boys to decide.

There are a number of ways to give stock markets a rude awakening. The US dollar is staging a recovery as investors bet on imminent rate hikes and weakness of other major currencies. I have little love lost for the US dollar but compared to other major currencies, it is a safe haven. The euro may come under intense pressure if highly leveraged members start clamoring for bailouts.

The flight to safety could lead to the unwinding of carry trades which will further strengthen the dollar. During the financial crisis in 2007, the unraveling of the Japanese carry trade was painful. But it will pale in comparison to the destabilization created by a stampede out of the US dollar carry trade positions built up this year.

Even Jim Rogers who has been arguing that the US dollar is collapsing is buying dollar for the past two months. He remains a commodity bull and will sell dollar on the rebound. The US dollar dominance will not last but its revival means we should hedge our positions or take some profits.

Besides the US dollar gyrations, sovereign debts are another major concern. Last month, Dubai World dropped a bombshell when it requests for a standstill on debt repayment. The writing was actually on the wall for businesses in Dubai as they could not collect payments for months and projects came to a standstill, but for unknowing investors sold on the compelling Dubai fairytale, they were just not prepared that their “triple A safe” investments could again have the makings of a fraud.

The general assumption was that Dubai World is a government owned entity backed by oil revenues in UAE. However, that crashed to reality when the Dubai government distances itself from the the problems in Dubai World. Fortunately, the timely $10 billion loan provided by Abu Dhabi, on the day Nakheel was to default on its bonds, saved the bonds market from a confidence crisis.

However, before investors can heave a sigh of relief, the threat of Greece defaulting on its sovereign debts hit the headlines. Greece’s deficit stands at about 13% of GDP (close to the US level) while its debts are expected to rocket to 113% of GDP against an EU target of 60%. Clearly, such profligacy is a recipe for disaster.

Europe has no lender of last resort and the members are reluctant to pay for Greece’s irresponsible behavior out of moral reasons. Without a bailout, Greece has to slash deficits aggressively or face currency revaluation. Reduced spending and tax increases are inevitable but austerity is easier said than done, what with soaring unemployment, plunging asset prices as well as strikes and violence by anarchist mobs.

Pressure continues to pile on the Greek government after Moody downgraded its credit rating, following in the footsteps of Fitch and S&P. Due to the higher credit risk, the spread for Greece government bonds increased, implying higher interest rates for new or rollover loans.

Greece may be the first member of the European Union to be brought to its knees by the debt markets but it won’t be the last. Other participants in the debt binge include Austria, Belgium, Italy, Spain, UK, Japan, and not to forget America.

The US run larger deficits than any of its counterparts, to the tune of $1 trillion per year (maybe more with social and medicare obligations coming), the day of reckoning when lenders refuse to finance these deficits is approaching.

Yet, there is no sign of America slowing down in its spending, despite debts crossing $12 trillion. The Treasury expects the bailout to cost $200 billion less than expected, and that it should be able to recover most of the money it lent to financial firms.

Great news but if you think excess TARP funds can be directed towards cutting deficits, you are wrong. Obama is already planning for stimulus package III and Timothy Geithner wants to use the money to purchase Treasuries. The ideology of “deficits don’t matter” is too deeply engrained in America’s psyche.

If creditors start to get tough, will there be simultaneous sovereign defaults including America? William Buiter leaves us in no doubt, saying: “The massive build-up of sovereign debt as a result of the financial crisis and especially as a result of the severe contraction that followed the crisis, makes it all but inevitable that the final chapter of the crisis and its aftermath will involve sovereign default, perhaps dressed up as sovereign debt restructuring or even debt deferral….”

Investing In Gold

The global economy recovery depends on borrowed money. America will continue to spend until they can’t. Can your investments weather the shock of sovereign defaults? The best way to protect yourself is to buy a few ounces of gold.

Some analysts believe gold is a bubble but I don’t think so. Yes, it has fallen about 10% off its peak of $1226 an ounce and may even correct below $1000. Nevertheless, the fundamentals are intact to send gold higher in the next 5-6 years. Gold will react favorably to global stimulus efforts, which are forcing governments to print cash and erode purchasing power.

Inflationary pressures are building up strongly and will likely erase deflation in the new year. Inflation is a silent tax which affects everybody but for those who are are heavily leveraged, it lightens their burden as debts are paid with cheaper dollars. That is certainly more appealing than scrimping and depriving yourself of material comforts.

Compared to deflation where people hoard cash and demand declines, economists will like to convince us that inflation is good as it pushes up assets prices, provides jobs, increases income and investment and boost tax revenues.

Well, inflation will be back with a vengeance and that will be reflected in the commodities market. There is no need to keep track of the funny money created as gold preserves our wealth by tracking inflation closely.

Also, if you believe in Jim Rogers, commodities are in a bull market and we are only half way through. As a long-term gold investor, the daily movement in gold prices should not concern you – just buy gold on the dips and sell only when gold reaches a mania. Though gold is on a super bull run, weigh the risk-rewards carefully when using Cash Advance to enhance profits.

Keep An Eye On The Exit

It bears remembering that the stock market is forward looking (about 6 months), so if you expect interest rate hikes in the later half of half of 2010, keep a close eye on the exit door when summer comes around.

When stocks are rising, it is easy to be suckered into the stock market as everybody wants a piece of the action. However, your world will come crashing down if the music stops after you invested your life savings. The key to successful investing is not to lose money or at least, not too much of it.

It is hard to stay on the right side of the bets all the time. You can be less wrong though if you choose sectors which are resistant to rate hikes, like gold and natural resources. The financial sector has hidden risks in delinquent mortgage loans, derivatives and sovereign defaults but having some exposure to quality financial stocks can provide strong upside potential.

For those who do not want to invest, it is best to save up your money and wait for better opportunities since valuations are high right now. Prices will definitely come down as we are in a secular bear market which may extend beyond 2015, if we consider 1999 as a starting point.

I suggest fixed deposits as the best option to preserve your principal. They are guaranteed by the state, in the case of bank runs. Long-term bonds or structured deposits are not fail-proof.

While they offer higher yields than fixed deposits, the returns have to weighed against exposure to credit risk. Ask yourself if it is worth getting the slightly higher yield, only to suffer losses to your principal in a black-swan event, which can wipe out your returns many times over.

That is all for now. Happy New Year to you guys. By the way, what are your investment expectations in the new year? More profits or losses? Going all out or cutting back?

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Filed under Currency, Deflation, Economy, Inflation, Stocks

8 Responses to Don’t Be Suckered By Stock Market Rally In 2010

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  3. I agree there are risks to the economy. Flooding a few large banks and insurance companies with hundreds of billions in liquidity is a very bad strategy. And the deficit spending is far too large given the huge debt we took on when the economy was bubbling away. The lack of savings (for the last 15-20 years) in the USA economy is a huge problem.

    I agree the stock market seems much pricier than Dec of 2008. I am not sure the answer is to leave the stock market. I am considering reducing the stock market allocation of my investments (I did actual sell some in one of my retirement accounts). But I have not reduced the percentage of current retirement contributions – though I am considering it. I did increase my equity contributions in Dec 2008 which so far has been quite successful.

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  5. Very well written article. I agree with you and I had sold off 75% of my equity unit trusts for the past 2 weeks.

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  7. stock markets are not as easy to predict, because it takes a lot of statistical analysis, to improve it, so you have to know how it analyzes, and according to the analysis, taking the best measures of the case.

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