ALBERT HERTER

‘SIZING UP THE CONVENTIONAL WISDOM FOR 2010, ‘ by James B. Stewart at SmartMoney via fidelity.com.

In Uncategorized on January 7, 2010 at 05:16

Sizing up the conventional wisdom for 2010

BY  JAMES B. STEWART,  SMARTMONEY — 01/05/10

With a new decade at hand, it’s time to close the books on 1999-2009, which will enter history books as the worst ever for stocks by some measures. It’s such a departure from historic norms that I feel pretty comfortable with my first prediction for 2010: The new decade will be better for stock investors.

As I’ve often said, I don’t put much stock in predictions about the inherently unknowable future, such as the direction of stock prices and interest rates. No one consistently gets it right, which doesn’t stop people from trying. And all of us have to make assumptions about the future whenever we invest. When the CW — the conventional wisdom — about what’s going to happen turns out to be wrong, there are big profit opportunities. So as we venture into this new decade, here’s what the CW seems to be predicting — and where I think it might be wrong.

Stocks: The CW always responds to momentum, and coming after the best year for stocks since 2003 and one of the best ever, the CW sees the rally continuing. With averages still well below their highs of 2007, and the economy in the early stages of a recovery, there’s plenty of room for continuing gains, or so the argument goes.

I never hazard a prediction for future stock prices, and instead follow the Common Sense system of buying on weakness and selling into strength. But the overall bullishness on stock prices for 2010 strikes me as too pervasive. Stocks have experienced a virtually uninterrupted ascent since hitting their lows in March 2009, and we know that stocks do not move in a straight line. They didn’t during the 1930s or earlier this decade, the last time we experienced such sharp rallies after a crash. I expect at least one correction of 10% or more this year, which will represent a buying opportunity. For now, I have a larger than usual cash position and, as I’ve written in this column before, have bought some short index exchange-traded funds in anticipation of a correction. Once that’s behind us, I expect the rally to resume, with modest gains by the end of the year.

Interest rates: The CW sees interest rates rising, especially after the Federal Reserve begins removing some of its support at the end of March. Long-term rates, set by the market rather than the Fed, have already crept up from historic lows.

In one sense, the CW has to be correct. Short-term rates, now essentially at zero, can’t go any lower. So rates are going higher eventually. The question is when. In its recent pronouncements, the Fed has been unusually explicit that it won’t be raising rates anytime soon, which I take to mean at least six months. Fed Chairman Ben Bernanke has said he wants greater transparency and predictability, so I can’t believe he’d encourage investors to rely on these statements and then renege.

My sense is that the risk of rising rates (which depress bond prices) over the next six months is minimal. Fixed-income investors should worry more about credit quality. As a result, I’ve bought some municipal bond funds, whose yields remain unusually high compared to U.S. Treasurys. I’m avoiding junk bonds. Midyear, I’ll be looking for signals from the Fed that higher rates are coming. I expect some Fed tightening by the end of the year and modestly higher rates.

International: The CW sees emerging markets, especially the BRIC countries (Brazil, Russia, India and China) leading the world out of recession.

Just because it’s conventional doesn’t mean the CW is wrong, and in this case I agree. The financial shocks that hit developed markets were far milder in the fast-growing areas of the world like Brazil and China, which are currently experiencing much more robust recoveries than Europe, Japan and the U.S. In my view, most investors still have far too high a percentage of their money in U.S. assets. I’ve recommended a non-U.S. allocation of 50%, with half of that in emerging economies.

That said, many foreign stock markets have recovered even more dramatically than the U.S. — and the crisis in Dubai was a reminder that rapid growth creates its own risks. Foreign stocks are vulnerable to a correction, and I predict one will emerge in 2010. That will be the time to re-allocate a larger share to emerging markets.

Meanwhile, the boldest contrarian move is Japan. The CW has all but given up on what still remains the world’s second-largest economy (soon to be overtaken by China). Developed Europe is close behind. Though these markets have disappointed investors for years, valuations look attractive. One diversified way to make such a contrarian investment is through one of the many EAFE (Europe, Australia and Far East) index funds.

So here’s to 2010. May it offer many opportunities and bountiful returns.

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