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How to Invest Now to Cash in Big During the Recovery

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Economic forecast from Allen Sinai, PhD

Now that the markets have rebounded sharply from their lows of March 2009, bears are warning that stocks are due for a big downturn. After all, the unemployment rate is about 10%, and the economy’s recovery is tepid. But those pessimists don’t appreciate how resilient the markets can be.

By the second half of 2010, I expect the Standard & Poor’s 500 stock index to hit 1,250, up about 14% from its early December 2009 level of about 1,100, and the Dow Jones Industrial Average to be somewhere between 11,500 and 12,000, up between 12% and 17%. Stocks are likely to continue rising into 2011, even though there likely will be pullbacks of anywhere from 5% to 15% along the way.

Why the economic outlook still offers great investment opportunities…

EARNINGS, YES… REVENUE, NO

For 2010, I expect S&P 500 earnings to climb 20%, on average, from the year before. Stronger earnings and fatter profit margins will result mainly from effective efforts by companies to reduce costs, rather than from any big jump in revenues. At the first signs of recession more than a year ago, many employers started to cut payrolls sharply. Businesses outsourced some jobs and began making more effective use of technology. All that has increased productivity and helped companies squeeze more profits out of anemic sales.

Moderate growth in the economy also should start to slowly push up revenues and fatten bottom lines. I expect the gross domestic product (GDP) — the key measure of the nation’s economic output — to rise by about 3% in 2010. That’s not nearly as strong as is typical after a recession but much healthier than what was happening last year. The growth will come partly because of increases in population. Consumer spending on necessities, such as health care, housing, food and basic services, rises relentlessly, even during recessions. In addition, heavy spending by the federal government will help the economy as Washington continues to support state governments and pay for infrastructure projects. Increased revenue from overseas sales also should help.

In a typical cycle, stocks begin rising before the economy hits bottom, as was the case beginning last March. This occurs because investors anticipate better days ahead and bid up share prices before the proof materializes. As stocks rise, consumers and businesses gain more confidence and begin spending more. As revenues increase, companies order more business equipment and eventually begin hiring. Gradually, the recovery gains momentum.

The current anemic recovery will limit earnings growth but not so tightly as to end the bull market in stocks. Bull markets have lasted an average of nearly five years but have ranged from three to 10 years. The current bull market began on March 10, 2009, and I expect it to last only three to five years. The cycle will prove relatively short because economic growth this time very much depends on government spending, which could begin trailing off when the current fiscal stimulus ends in 2011.

BEST STOCK SECTORS

To take advantage of this bull market, focus on stocks in these sectors…

Financials. Bank stocks and other financial stocks already have rallied steeply, and they will continue leading the way as the global economy recovers and credit markets improve. As the market continues climbing, there will be more activity on Wall Street, with companies acquiring other companies and issuing new shares to raise cash. The picture for banks will improve as consumers and corporations resume borrowing, although risks surrounding consumer and commercial real estate loans will limit the earnings gains of regional banks, and there will be many more bank failures.

Technology. To operate efficiently in a challenging environment, businesses must spend more heavily on hardware and software. When companies do hire, they must outfit employees with computers and printers. These days, more and more employers consider it necessary to supply a BlackBerry and other wireless gadgets as well.

Health. In recent months, many health-care stocks have lagged as investors worried that new government regulations would shrink profits. But those changes actually may increase demand for health-care goods and services of all kinds. And health care will remain one of the fastest-growing sectors in the US and globally.

Energy. I expect oil to reach $125 a barrel by the end of 2010, up from the recent price around $70. As the global economy recovers, demand for oil will put upward pressure on prices. Suppliers will restrict supply, trying to offset the effects of a weak dollar.

Foreign stocks. Overseas markets should outperform Wall Street. For investors, this means it will be wise to emphasize big US exporters that benefit from an expanding global economy. The outlook is especially bright for stocks in emerging markets, particularly in Asian and Latin American countries. As millions of consumers in emerging markets enter the middle class, many are buying cars, phones and other consumer goods for the first time, fueling economic growth.

BOND CAUTION

Investors should limit their exposure to long-term bonds. When interest rates rise, prices drop on existing bonds, especially long-term bonds. To head off a surge in inflation, the Fed will likely boost its key short-term interest rate — the federal funds rate — from near 0% recently to 1% by the end of 2010 and probably more than 2% in 2011. Yields on 10-year Treasuries likely will exceed 4% in 2010, up from 3.4% recently. Mortgage rates, recently below 5% on a 30-year loan, will be higher, too, and savers will begin seeing some decent returns again on short-term investments.

WHAT’S AHEAD FOR JOBS

Even though stocks will thrive, the overall economy will be sluggish. Employers will remain reluctant to hire at a time when rising health-care and retirement costs make it too expensive to add many more workers.

After the recession of 2001 hit bottom, it took two years before significant job growth appeared, so economists talked about a jobless recovery. The current one could turn out to be the mother of all jobless recoveries.

Layoffs gradually will decline. By the end of 2010, payrolls should be increasing by between 50,000 and 100,000 a month. But the increases will do little to whittle down high unemployment. The unemployment rate, which was 10% in November, will likely peak at 10.5% or higher in the first quarter of 2010. By year-end, it still will be more than 9.5%, but the weak job markets will not be severe enough to derail the stock market.

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Source: Allen Sinai, PhD, chief global economist and strategist at Decision Economics, Inc., an economic advisory firm in New York City. Sinai has been the top economic forecaster in annual surveys in USA Today and The Wall Street Journal, and was chief global economist at Lehman Brothers, Inc., from 1983 to 1996, prior to starting his own firm. www.pdeeco.com
Date: January 15, 2010 Publication: Bottom Line Personal
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