The markets' sweet spot will end in 2010
Dec 24, 2009
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Equity markets produced "a turbo-charged performance" in 2009, says Jeremy Batstone-Carr of Charles Stanley. The S&P 500 has soared by 63% in just nine months. The FTSE 100 is up 47% from its March low.
Analysts are predicting further, albeit more modest, gains in 2010. Surveys in The Sunday Times and Barron's show an average forecast of 10% and 12% for the FTSE and S&P respectively.
But given the potential pitfalls ahead, that seems optimistic. As Batstone-Carr notes, "unprecedented" levels of government spending and a "tidal wave of liquidity", thanks to rock-bottom interest rates, have been crucial to the rally.
But those props are set to be gradually removed as the recovery takes hold and interest rates are raised. Unless the economy "really kicks into a higher gear, investors could face the worst of both worlds: tepid growth and higher borrowing costs, not to mention higher taxes", says Kopin Tan in Barron's.
The trouble is that that this downturn has not been a "typical recession", says John Mauldin on Investorsinsight.com. The recovery is likely to be lukewarm. Following the credit bust, consumers and the private sector, especially banks, are deleveraging, a process that is "nowhere near complete".
Given the fragile economy, what investors "should really be concerned about is if the Fed doesn't feel able to raise rates soon-ish. That would suggest equity investors have priced in a much rosier economic scenario than will prove to be the case," says the Financial Times. The bottom line is that the 'sweet spot' that markets have been in for the past few months – ample liquidity with no rate rises on the cards – looks set to end one way or another in 2010.
Another danger for equity markets everywhere is a rebound in the dollar, now at a three-month high against the euro. The dollar carry trade has underpinned risky assets ranging from stocks to commodities, and according to Credit Suisse it is worth at least $1.4trn. As investors unwind their trades amid a dollar rebound, risky assets are vulnerable to rapid sell-offs. Credit Suisse reckons the unwinding carry trade is the "greatest risk" facing the world in 2010.
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