10 for 10: Thoughts for 2010

2009
represented a truly remarkable year in financial markets.  As we head into the New Year, we present our
thoughts on the likely outlook for 2010, set out in our Top 10 list below.  What seems clear to us is that the actions of
the central government and the central bank appear to remain aligned with the
best interests of investors. The Federal Reserve seems determined to keep rates
low to foster a re-inflation of the economy and the stock market, with a good
chance that rates remain at zero for the entirety of the year, while almost 80%
of the US
government stimulus remains unspent, which should continue to fill the gap of
depressed consumer demand. Unfortunately, this too shall pass and eventually,
rates will need to go higher and all of the IOU’s that are being written will
need to be repaid. We don’t think this occurs in 2010, but should it become
apparent that the authorities are jumping the gun, the view will need to be
altered (i.e. if the facts on the ground change, the view needs to change with
them). For now, we appear to be on the right side of the cycle and over the
next decade or two, this could be the key to making money. Anyway, let’s get on
with the countdown:

The Market goes far higher than most people think: Implicit within this call, we do not believe in the double dip
recession. We would argue that in an environment of low bond yields,
institutional investors (and particularly pension funds) are likely to need to
move up the risk curve in order to meet expectations and obligations.   While
the longer-term outlook remains challenging, there are likely to be windows of
opportunity and we believe that 2010 could present just such a window.

The Fed stays on hold for the entirety of 2010:  We believe that despite what
could shape up to be several quarters of strong growth, policymakers are likely
to err on the side of keeping policy loose for fear of risking the “mistakes”
of the Great Depression (which, may, in fact, have not been mistakes at all).
Some have forecast a Fed hike as soon as the summer, while others have
discounted a third or fourth quarter hike, but we would bet that we see no
activity out of the Fed for the entirety of 2010, which is bullish (at least
from a short-term perspective) for risk assets.

Yield carries the day: Let’s With the
prospects of a blended 4% yield from a cash/bond portfolio in 2010 (and this
may even be a tad aggressive), and no clear avenues in the fixed income market,
we would suggest that we might begin to see a shift from bonds into dividend
paying stocks, where there is the prospect of higher yields, capital gains and
dividend growth. To the latter point, 2010 could potentially set up to be a
special year on the dividend growth front, as many companies hoarded cash in
2009 to defend against the ongoing credit crisis and the potential for new
regulations. Once these new rules are implemented, it could be game on again
for dividend hikes and we could see some “make up” for the increases that were
foregone in 2009. Layer on top of this the aging baby boomers and their
increasing income needs and there is an even more favourable backdrop for high
dividend payers.  

George Clooney gets an Academy Award:
Let’s forget the fact the ladies find him attractive and instead focus on what
was the best movie of the year this side of Star
Trek
. Up in the Air sends a
strange message about hope and what’s important in life, even when there seems
to be very little hope. Since Billy Crystal gave up on hosting, the Oscars have
tended to be a crashing bore, but we’ll tune in to watch GC and the most
expressive smile in Hollywood
accept his first Academy Award for acting.

Housing “double dips”: The green shoots
crowd has gotten excited about the bottoming in US housing, which appeared to occur
during the summer. We believe this optimism will prove to be misplaced as 2010
moves along. Mortgage rates have been kept artificially low thanks to direct
and indirect government subsidies, but these are due to end in March.  Although it’s possible the government moves
to extend them a while longer, we would assume that they will end at some point
in 2010. Layer on top of this a wave of mortgage resets from the 2005-06
vintage, many of which are in negative equity positions (a recipe for default),
and a potential shadow inventory of hundreds of thousands of more foreclosed
homes that the banks have yet to re-release to the market, and there could be
some dark days ahead for US housing. We don’t believe we’ll see on the order of
30% declines, but prices could fall a further 5-10% from here.

Gold makes new nominal highs (without an outside shot at new
inflation-adjusted highs):
Quick quiz – which of
the following was the worst performer in 2009 – copper, nickel, zinc, silver,
oil, gold? If you said gold, you win the prize, as it badly lagged other
commodities, yet it seems everywhere we read in late 2009, gold was in a
terrific bubble. In terms of outlook, we think we are in for years of
government intervention in the economy, as private demand will fall short of
expectations. When the government intervenes, it tends to print money and this
is good for gold, which is closely tied to the money supply. Add to this what we
think will eventually be a pretty big inflation scare, as loose monetary policy
breeds asset bubbles, and you get a very favourable backdrop for gold.

If there is a correction, it’s in Q2 or Q3: Over the remainder of 2010, investors should watch for crucial
indicators that may point to why 2010 may not unfold similar to 2009. In other
words, these indicators could foreshadow when difficult times for the market
are near. 

* Valuations begin to rise significantly and optimism becomes
excessive.

* If it becomes apparent and more convincing that higher interest
rates are imminent

* Staple Sectors (Healthcare and Utilities) begin to outperform
Cyclicals

Oil Cracks $100 level: Oil has been
surprisingly resilient in first month of 2010, despite US dollar consolidation.  The backdrop is there for oil to outperform
in 2010, with a fragile geopolitical environment, a recovering North American
economy potentially spurring some demand and the continued insatiable demand
appetite of emerging Asia.  We believe that the demand side of the
equation, which was sorely lacking in 2009, could come back at the same time
that supply shocks are hitting the balance.

The US dollar could end higher versus developed nation currencies: There is massive loyalty, by those invested in the carry trade, that
the dollar will continue to falter, due to massive debt and trade deficits,
zero interest rates, near $60 trillion in unfunded liabilities across social
security and other programs, and Bernanke printing as fast as a military
helicopter blade with the overdrive button depressed. From today’s levels, the
dollar could well rally against the Pound, Euro and Yen because not only is the
bad news already priced in, but there are so many, many bears. With waves
bashing and all on one side of the cat boat, it’s easy to be catapulted to the
other side. And when valuations are supported by excessive unrestrained optimism
or pessimism, a 180 degree turn could well be around the corner. The respective
strains from high unemployment and the oversized deficits of Spain, Ireland,
Portugal and Greece could prove painful for the 16 nation
Eurozone’s currency and similar stresses are in place for both Japan and Britain. Note that we believe the
commodity based currencies (Canada,
Australia, and Norway) will
remain respectively strong versus the dollar. 
   

Preferred Asset Mix: Putting aside the
fact that everyone’s goals are unique and varied, and is only a general opinion,
one might consider designing a starting point for 2010 as follows:

The views expressed are the opinions of the
writers and may differ from the views of Royal Bank of Canada or its
affiliates.  Stephen Price is an Investment Advisor with RBC Dominion
Securities Global Limited, which is regulated by the Cayman Islands Monetary
Authority.  Gareth Pulman is Senior Portfolio Manager with
Royal Bank of
Canada Trust Company (Cayman) Limited.  Both entities are part of RBC
Wealth Management.

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