- The Washington Times - Friday, January 1, 2010


Many would argue that “out with the old, in with the new” is the de rigueur mind-set this week as we exit 2009 and enter 2010. The same is true with the investors’ mind-set because after what looks like will be a close to a 25 percent return for the stock market this year, per the upward move in the S&P 500, all the investment return dials are set to zero on Friday.

Despite the nice run that this year’s Santa Claus rally has brought — roughly 3 percent as I type this — Jan. 1 means back to square one and the race begins anew for money managers and personal investors to try to match or exceed the stock market move in 2010.

This, of course, prompts the rather obvious question: What will the stock market do in 2010? As you would expect, there is no shortage of prognosticators offering their takes, but how do we identify the true prognosticator of prognosticators? Recent headlines include: “Stocks Poised to Ride Higher in 2010,” “Citi, the Can’t Lose Trade of 2010?” “2010 Investment Strategy: Watch Those Dividend Yields,” “Freddie Mac see rates headed to 6 percent by end of 2010,” and “Timid in 2010: Employers will hire, but reluctantly.”

Well, I’ve never claimed to be the Punxsutawney Phil of stocks and I am not going to start now, but what we should be pondering is the thought process behind some of these forecasts. Once again … let’s break down some of these predictions into digestible arguments and test the underlying assumptions to see whether we agree or disagree with them. After all, how many times have we heard the pro-business argument that one plus one can equal more than two, when in reality it’s lucky to add up to two.

Tracing back the stock market, again as measured by the S&P 500, over the past 30 years, we find some interesting and conflicting data. First and foremost is the realization that the S&P 500 is up more than tenfold compared with in 1979 and more than threefold since 1989 but is down 23 percent compared with in 1999. That last comparison is one of apples and oranges in my book, and I say that because the market in 1999 was still in the early stages of the Internet bubble. But the market in 2009 reflects either a recessionary environment or the early stages of an economic rebound, depending on how you see the world today.

Second, other than several consecutive years of strong positive double-digit returns posted from 1995 to 1999, significant move in the S&P 500 is followed by a year of less impressive returns. Now, that can be negative returns, as experienced in 1981 and 2000, or positive returns that are well below the prior year, as was the case in 1986, 1992 and 2004.

Taking a look at expected earnings growth for the S&P 500 in 2010, the current consensus forecast calls for it to deliver operating earnings of $74.24, which is up 27 percent over the $58.47 that is forecast for 2009. Funny thing about that 2009 forecast, we have yet to see how earnings for the last quarter will shake out. This means it could be somewhat higher or lower and will hinge, more likely than not, on how holiday sales fared. But back to that 27 percent earnings growth forecast for 2010. The last time the market posted such year-on-year earnings growth was in 1993; since then, earnings growth has averaged 6.2 percent year-on-year.

The question becomes the following: How likely is that 27 percent earnings growth forecast? With earnings growth of that level achieved in only six of the past 49 years, odds are pretty low in my opinion. Moreover, if we consider some of the prognostications mentioned above - higher oil and gas prices, unemployment at lofty levels, prospects for higher interest rates, increasing unemployment taxes and the potential impact of a new health care system - it becomes difficult to envision earnings growing that quickly in 2010.

If the market’s earnings growth falls short but is still positive - as happened in 1994 to 1995 and 2002 to 2006 - the S&P should trade at about 17 times average per-share earnings, roughly equivalent to its average over the past half-century. If the optimistic pundits are accurate and 2010 corporate earnings grow 20 percent over 2009, such an “accorded multiple” would have the overall S&P index trading at 1,228, about 9 percent higher than it does now. An even more optimistic 27 percent earnings-growth scenario would have the overall S&P trading 15 plus percent higher than it does now.

Again, it all hinges on whether the 20 percent to 27 percent year-on-year earnings growth is achievable.

As we ponder this, we have to remember not only that the economy and the stock market are two different animals, but also that neither can be underestimated. Even so, the move in the stock market from March until the end of 2009 looks a lot to me like the pendulum has swung pretty hard in the opposite direction compared with where it was in the first quarter of 2009. With that in mind, the pendulum could start to swing back should there be signals that the economic rebound is less than expected. Should that be the case, we have to steel ourselves for a bumpy ride in the market as well as the prospect that it could be flat to down in 2010 compared with 2009.

One last point, much the way the stock market was a roller-coaster ride this past year, we have to remember that where we start and finish 2010 probably will not be a straight line - there will be bumps and challenges along the way. That said, I and other would-be Punxsutawney Phils probably will revisit our market expectations in the coming quarters. Let’s hope those revisions will be less frequent than changes by the local weatherman each week.

Chris Versace is director of research at Think 20/20 LLC, an independent research and corporate access firm based in Reston, Va. He can be reached at cversace@washingtontimes.com. At the time of publication, Mr. Versace had no positions in companies mentioned. However, positions can change.



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