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10 Predictions for 2010

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By NICKDAWG
January 4, 2010

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Get ready for a new decade! As this past decade has shown, when it comes to the world of investing it is best to zig when the markets zag. In 1999, the conventional wisdom was that S&P 500 index funds were a low-cost one stop shop for every investor's needs. As we now have painfully experienced, the S&P 500 return for the decade was absolutely miserable and it was those investors who diversified out of stocks into bonds, international markets, commodities and precious metals who benefited financially. In 2010, true to the "fighting the last war" phenomenon, the conventional wisdom now espouses that diversification through a variety of ETFs and low cost mutual funds. It's not a terrible strategy I don't believe that it will lead to substantial outperformance any more than the S&P 500 indexing did. What will work in the 10s? Here's my best guess: trading strategies that take advantage of market volatility (e.g. buying low and selling high in a churning market), concentrated sector bets (in particular, sectors that have pricing power in an inflationary environment) and old fashioned stock picking. Without getting into a dissertation as to why, I am comforted that these strategies almost seem to be on the lunatic fringe compared to current market wisdom.

In 2009, my prediction of a "bond picker's market" was about as close a description to the major theme of the year as you could get. The non-Treasury bond rally was somewhat indiscriminate but certainly amazing. In 2010, my core theme is "Booooring". After the "financial fireworks" of the last few years, we may have forgotten that finance (and the markets) are very often extremely boring as business strategies and valuations take years to reflect themselves in stock prices. The flow of financial information and the hyper-aggressive trading has served to make markets correct more quickly but, at least in 2010, my guess is that the various forces in the market will roughly cancel each other out. All of this will add up to a fairly unmemorable year in the financial markets.

1. 2010 is a Boring Year for Asset Prices-Value and Dividend Strategies Outperform

As mentioned above, we are due for a "boring", plodding year for asset prices. I am not sure that precludes significant swings in the market but at the end of the year, my prediction is that asset prices won't be too far off from where they started. The cheapest and most unloved portion of the market appears to be boring, income producing stocks (think utilities, for instance). My guess is that in a boring and trendless year, they will outperform.

Investment Thesis: Consider adding quality income stocks as core holdings.

2. Managed Funds will Outperform Indices

The art of stock picking appears to be a dying art as the world has punished underperforming active stock managers and more money has migrated to indexes, ETF or other passive products. Of those manager who have survived, many of them employ passive indexing strategies anyway. If stock pickers are ever to earn their keep, 2010 would be a year to do that as the conditions for outperformance of individual stocks versus indexes appear to be in place.

Investment Thesis: Devote time to stock picking or find an excellent stock picking manager.

3. The "VeggieLattes" Prevent Further Steepening of Yield Curve

You have heard the legendary stories of the bond "vigilantes" who sniffed out inflation and forced up yields on overspending governments. Well, after a nearly 30-year Treasury bond bull market, those "vigilantes" have given way to a new breed of bond investors, the "VeggieLattes" as I like to call them. The "VeggieLatte" bond investor is truly extraordinary: they do yoga in free moments in the trading day, they eat the latest fashionable things, they amaze us with strategies of "rolling down the yield curve", they run enormous mutual funds and they jump buildings in a single bound. Lost in all of this is that the are mostly bullish on bonds (kind of hard not to be when that is what you are paid unbelievable sums for), have been investing in a bull market for decades and, in 2010, getting old fast. Should there be an investing rule against a 65 year old bond manager investing in 30 year Treasury bonds that are due to mature when he/she would be 95 years old? If not, perhaps you should consider one personally. Consider that a baby boomer born in 1946 turns 64 in 2010. How many 30 year Treasury bonds will he/she be buying for the rest of his/her life? Unless they plan to bequeath an amazing inheritance of Treasury bonds, the number must be at or near zero. So, if you are buying these bonds, who is going to buy them from you? In the meantime, the "VeggieLattes" (and the banks and pension funds that use similar strategies) rule the game and my guess is, at least for 2010, that they will prevent further steepening of the long end of the Treasury curve.

Investment Thesis: Yield curve will retain a similar shape, may flatten slightly. But I would advise individual investors to let someone else play this game. In my opinion, under current conditions, the Treasury market or investing in bond funds that have substantial Treasury holdings are both extremely risky vehicles.

4. US Stocks Up Small

As discussed above, I expect a churning, boring year for the stock market. In the end, I believe that the US stock market will rise on a single digit percentage basis.

Investment Thesis: Buy on any 10% dips, sell on any 10% rallies. Lather, rinse, repeat.

5. Commodities Rise

Quick, name an asset class that has gone up nine years in row? How about gold! I am not certain that gold will make it a perfect 10 in 2010 but I believe that commodities are going higher overall, led by agricultural commodities and industrial metals.

Investment Thesis: Maintain a core holding in commodities.

6. European Currencies Suffer as at least one European country is forced to devalue currency/reevaluate plans to adopt Euro

There has been a lot of focus on the weaker EU countries in 2009 (Portugal, Ireland, Italy, Greece, Spain) but they have adopted the euro and are still tied to the rest of Europe. When you go outside those countries, though, does anyone really believe that countries like Latvia and Estonia could adopt the euro at current exchange rates? I, for one, do not and I expect the admission of that will send ripples through the currency markets and the European banking system. This will weaken European currencies generally, particular those on the outside of the EMU. The yen will weaken due to continued high Japanese budget deficits. I expect strength in the (relatively) higher yielding Aussie and Canadian dollars and a good year for the US dollar as a refuge.

Investment Thesis: Long: US, Canadian and Aussie Dollars. Short: Swedish krona, Hungarian florint and Japanese Yen.

7. US Banking System Stabilized

The extraordinary support measures for the banking system appear to have had an effect and the worst of the crisis appears to be over. Loan losses will remain high but the steep yield curve will allow banks to make money in their core businesses. The next crisis is closer than we all may believe but, for now, conditions are ideal for solid banking profits.

Investment Thesis: Consider investing in well run banks.

8. High Yield Bonds Outperform Safer Issues

With the zero interest rate policy and a shortage of high yielding, solid credits, I expect the search for yield to continue and that will bolster prices of riskier bonds. There is no way that the performance of 2009 could be repeated but high yield and private label mortgage debt will outperform again. I expect returns to largely be in line with bond coupons.

Investment Thesis: Maintain exposure to higher yielding paper. Keep duration short.

9. International Stocks Advance with a Focus on Developed Markets and Value Stocks

Emerging market and international stocks roared back in 2009 and there appears to still be considerable momentum in the economies and asset flows. Since valuations in the BRIC countries appear a bit stretched, I believe value issues and developed country international stocks will outperform.

Investment Thesis: Go long international value stocks.

10. Democrats Punished in 2010 Elections

Despite an improving economic and job picture, mistrust of the US government still runs deep. I expect that incumbents, particularly Democrats, will be punished for the last few years and voted out of office in record numbers.

Investment Thesis: Short your least favorite incumbent elected official!

As always, have a great year, and happy investing!

NICKDAWG