Sunday, 13 December 2009

DECEMBER 09 Investment Outlook

Whether you've been tucking your hard-earned away in a pension, property, stocks, bonds or more esoteric investments, 2010 is likely to be a much trickier ride for us than the jolly we enjoyed in 2009. 

The low pressure weather system swirling around the debt crisis, temporarily staved off by an effluvium of monetary wind from the world's central banks, will gather strength and start heading inland at some point next year. 

Following another sag in house prices, banks will start to suffer renewed losses and reign-in their lending yet further; consumers, cresting in their age-related spending and with one eye on rising unemployment and the other on their mortgage, will prove unable to stimulate recovery as in previous recessions; and as interest rates begin to edge higher businesses, anchored by an overhanging belly of debt, will find it increasingly difficult to re-finance their loans or generate enough income to service their payments.

Add in one or two potential extraneous shocks (military conflicts, Eastern Europe going bust etc.) and I expect the cumulative effect of these problems to weigh increasingly heavily on the economy and markets as we progress through the year.

Please click on and open in new tab or window to view full size

Each month in this space I'll gaze into my crystal ball to try and divine the most profitable (or most risky) places to stash your money.  I'll give a brief overview of the outlook for each type of investment: savings, commodities (eg. gold, oil), property, bonds and stocks. 

Plus, each month I'll subject one of them to a more detailed analysis.  This month I'll concentrate on the outlook for stocks, which have had a rollicking ride up over the last nine months.  If you're in already in should you stay in? And if you're not, should you get in?  But first, let's look at...

  • The top fixed-rate savings accounts are being snapped up and closed faster than ever
  • Interest rates are being clipped as banks can now get funding cheaper elsewhere - it's therefore a good time to lock in fixed rates on cash you won't need for a year or more
  • Top ranked cash ISAs, especially those with fixed rates, offer excellent value

  • GOLD has had a parabolic run up and is in bubble territory; it may well go higher if the dollar's rise relents, but determined investors should only buy on a pullback to $1100 or below 
  • OIL is struggling as the dollar surges, but sentiment readings suggest another push to new highs is probable if the dollar turns lower.  A breakout above $80 or a pullback to $65 would be low risk entry points.





It's been a blast...almost literally.  We've seen the strongest surge in stocks since 1932.  I'm glad to say I spotted the bottom last March to within a day (and wrote so in an email update); yet although I've taken several bites out of the rally on the ascent, I can't say I've been fully invested all the way up due to my worries over the long term picture.

For some time my view has been that we're in a lingering sweet spot which, for all the reasons given in my December 5th post, cannot be sustained. Our mission therefore, if we want to protect ourselves yet not lose out, is to carefully milk the upturn for all it's worth, whilst simultaneously executing a market escape worthy of Houdini.

In October's Investment Outlook I re-posted the scenario for the Dow Jones Index I originally sent out way back in April and, as it still chimes with my overall view and has been spot on so far, let's take another look.

I'm featuring the Dow here, but the same basic story could be told for virtually any other major international index including the FTSE 100, since world markets remain highly correlated to the American stock indices and dependent on the US economy (markets in some emerging economies like Brazil and China show greater strength, but will still be capped by US / European weakness since they need fat-walleted and willing consumers to export to).

The chart above envisages a substantial reprieve for stock investors lasting some way through 2010, during which serious cracks begin to reappear in the bullish firmament, optimism gradually breaks down and the bear market resumes with a vengeance in 2011.

I didn't know it, but at the same time I was cogitating over this forecast some tight-suited nerds at Morgan Stanley were fondling their own crystal balls and coming up with a not dissimilar conclusion.  They researched a whole slew of major downturns over the past century - 19 in fact - in an attempt to figure out if there were any common themes and patterns in the subsequent market behaviour.

Turns out there are many. They looked at 'secular bear markets' aross several countries - that is, bear markets not caused by the cyclical factors which create your common-or-garden recession, but those mainly associated with credit busts and banking crises. They composited the results and published this generalized illustration of stock markets' typical performance over the next several years.

It's a sobering picture.  After a long downturn, the market rebounds strongly in a 'sweetspot' phase, with average prices rising 70% off the lows. We are currently close to fulfilling that requirement, having risen around 60% since markets hit bottom in March '09.  There then tends to be a substantial retracement of part of that rebound (an average drop of 25%) as investors fear, then get, higher interest rates...followed by a long, wide trading range: over this period of several years, prices do very little but zig-zag up and down between two points, the highest of which is still well below the peak set in the previous boom.

Overall, depending on where you bought, the story is for markets to return either next-to-nothing (excluding dividends) or else fall, over a period of more than ten years.

For a long-term 'buy and hold' or pension investor, this scenario is truly depressing. Keeping your money in stocks in such a market is like flashing your cash at a pickpockets' convention.  A whole world of risk for virtually no gain. If your stocks pay dividends you'll do better, but dividends are of course neither guaranteed nor fixed and capital appreciation over many years is likely to be non-existant to negative.

Morgan Stanley's research very much reflects my own view that we will reach a peak in stock markets at some point in the next year or so which is unlikely to be surpassed for a decade. This, I suggest, will be the moment for you and me to sidle to the wings, pack our bags and say thank you very much and goodnight. After the rollercoaster decade from hell, long-term investors are being gifted an opportunity to exit at somewhere near 'break-even' - and they're beginning to take it.

Lately, investors have been cashing out of American stocks and piling in to bonds.

You might imagine that most ordinary investors, having watched markets rocket since March, would be scrambling to get in.  But the data tells us that money is instead exiting the market at a steady pace.  This is a fascinating development, and has started alarm bells ringing with a number of savvy analysts.  This is because quite simply, markets need more and more ordinary investors to pile in as prices rise in order to sustain their advance. Usually this happens gradually as stocks come off a low point. Not this time. As David Rosenberg, widely respected former Chief Economist at Merrill Lynch recently noted:

And remarkably, he goes on to say:

To my knowledge this is the first time a senior working economist, whose opinions are highly influential, has publicly recognized the critical importance of demographics to our economic future.  Of course, dear reader, you've been suffering my rants on this subject for a year now but it's becoming increasingly clear to those who are prepared to look: ageing baby-boomers are not going to risk their retirement savings in stock markets which have, twice in a decade, left them badly burned.  

Not only that, money-managers investing on behalf of pension funds and unit trusts are starting to run out of cash.

Having been left flat-footed as markets turned and soared, they quickly jumped back in to try and grab some gains. But now their cash reserves, a major part of what fuels market rallies, are actually starting to run dry.

When this rare signal has been triggered in the past, looking back 60 years, it has always been a death sentence for a rally.  The turning point is not necessarily immediate.  The market can stagger higher for several months, but it's a clear warning that the fuel indicator for stocks is flickering red.

There are also some disturbing signs from other technical indicators that a correction of some kind is in the offing.  It's probable that this will be a modest pull-back in the rally rather than the beginning of a big move down, but given the bigger picture we can't be certain.  So here's the summary:


If you're thinking of investing new money into stocks, you should wait for a pull-back.  Technical signs are clear that indexes are ready for a pause, and there is a growing risk of a more substantial decline.  The FTSE 100 will begin to become interesting around 5100 but could go as low as 4950; the Dow is worth a nibble below 10,100 although a drop to 9800 is possible.  Even if stocks push a little higher in the next few weeks, don't be tempted to jump in - a fall is coming. 

Once the correction has run its course, I'd be reasonably confident of another attempt to push higher.  Despite the increasing headwinds, this may succeed and force the indexes to new highs.  The next technical targets for the FTSE range from 5500 - 6000; for the Dow, 11,000 - 11,250.  Beyond that, we find ourselves in rarified air.

Investing any money now on this kind of timeframe is fraught with danger, for all the reasons I've previously given.  Over twenty years or more there's little doubt you'll come out ahead, but in any case it would be far, far better to wait for the next major downdraft to hit before committing any funds long term.  A plunge back towards the lows back in March is a real possibility considering all the risks and the above market precedents. 
In the meantime, I continue to suggest a strategy of gradually taking your money off the table as we rise through the target levels mentioned, combined perhaps with taking out other forms of protection like warrants or options.  Check this link for comprehensive advice.  It's also possible to buy unit trusts and Exchange-traded Funds (ETFs) which profit as the market falls.  Adding these to your portfolio when the market is about to pull back can protect your profits whilst you decide whether or not to sell your investments longer term.
Pension holders, consider switching a portion of the funds your pension currently has in stocks, into cash.  Most pension funds will allow you to do this.  If yours does not, consider as a matter of some urgency transferring it to one which does, or into a SIPP - a self-invested personal pension - which enables you to take more control of your investment decisions.  How will you feel if, having been aware of the risks, stocks fall substantially and you cannot protect your pension?


Right, that's quite enough about keeping it, I'm off to spend it.  Time to spread a little Christmas cheer to the good shopkeepers of Oxford St.  That's your lot for 2009; next month's fun-packed blog and Investment Outlook will appear, hangover permitting, on January 3rd 2010.  Until then, goodnight, good luck, have a wonderful holiday and as the blessed Dave Allen used to say, may your God go with you!