On the heels of a year in which stocks fell to 12-year lows in March, only to reverse course and produce total returns of nearly 30 percent for 2009, investors are left to wonder what 2010 will hold.
Given the magnitude of the market declines in late 2008 and early 2009, skepticism abounds regarding the sustainability of recent gains.
Instances of normal market volatility, such as the period between Jan. 19 and Feb. 10, during which the market dropped 8 percent, create renewed anxiety and concern that stocks are starting down another slippery slope.
But 10 percent “corrections” have occurred about once a year, on average, since 1928, according to Ned Davis Research Inc.
Even though volatility measures have receded significantly in the past year, investors should expect more fits and starts during recovery from the most significant economic decline in nearly 30 years. Trends of traction
Today’s environment is much different than that of a year ago. This time last year, the economy was in decline.
Contraction in gross domestic product was nearly 6 percent in both fourth-quarter 2008 and the first-quarter 2009. Entering 2010, the economy has exited recession, growing for the past two quarters. This trend is likely to continue throughout the year.
Nearly 7 million jobs were lost during the recession, but an increase in the hiring of temporary workers in recent months and declines in new unemployment claims suggest that gains in permanent jobs are just around the corner.
So although the economy is still under repair, the trends are now moving in the right direction.
Nearly 80 percent of companies have beaten fourth-quarter 2009 earnings expectations, according to Bloomberg, as lean cost structures and improved productivity have allowed profit margins to expand.
While the economy is expected to grow by about 4 percent this year, this profit leverage should allow corporate earnings to grow by 25 percent to 30 percent in 2010. Based on current levels, the price-to-earnings multiple of the S&P 500 index is 14 times consensus 2010 estimates. This is a very reasonable valuation given current low interest rates and inflation. Back-to-back bear markets
Despite the strong finish to 2009, the market remains 25 percent below the peak levels of October 2007, reflecting the major dislocations of the past 18 months.
After weathering two significant bear markets in the past decade, the trailing 10-year average annual return for the S&P 500 index is negative 1 percent. This is not the type of experience that creates investor confidence, though history suggests that previous decades of poor market performance are typically followed by phases of above-average results. This process of “reversion to the mean” tends to draw periods of extreme performance – either good or bad – back toward long run averages over time.
Although market returns are impossible to predict due to myriad known and unknown factors that will influence prices within a year, several factors suggest that 2010 may be a productive year for stock market investors. These include:
• Profit growth is expected to be strong, and may continue to surprise to the upside;
• The economic environment is improving;
• Year-over-year comparisons are very easy, given the magnitude of the declines in late 2008 and early 2009; and
•The market’s valuation is reasonable based on forward, “post-recession” earnings.
Stocks or bonds?
Trends in economic and corporate fundamentals have turned positive, which should be supportive of stock prices in 2010.
Inflation should be relatively contained, but as global economies continue to improve, it could begin to rise later in the year. This, combined with the unwinding of the Federal Reserve’s quantitative easing program, might put upward pressure on interest rates as the year progresses.
From a portfolio allocation standpoint, stocks may perform better than bonds in the short run.Chartered Financial Analyst Jeffrey A. Layman is Chief Investment Officer at BKD Wealth Advisors in Springfield. He may be reached at firstname.lastname@example.org.