The timing of withdrawal of fiscal stimulus is crucial

Louisa Bojesen
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How will the markets look once central banks start withdrawing their massive stimulus packages?
This is what everyone wants to know, especially after the US Federal Reserve last week indicated that they would start this exiting process early 2010.

Lothar Mentel, chief investment officer of Octopus Investments says that we should not be too worried about a possible unwinding, but rather, we should worry about the timing of this move.
The moment support is withdrawn, markets have to be able to function on their own. Mentel says there is a significant risk that the timing won’t be right, and the more market players worry about this, the more of an issue it becomes. However, markets won’t necessarily fall just because support is withdrawn. Mentel points out that if we have good support from macro economic indicators, then withdrawing the stimulus packages could actually be seen as a positive, as we otherwise run the risk of inflation which could be a negative for the markets.

In the first quarter of 2010, Mentel says we should expect to be in a set trading range, but with quite a bit of volatility. He thinks it is more likely that we could see breakouts to the upside, but cautions on areas like commercial property and says there could yet be readjustments.

Many CEOs are currently in a situation where they have seen their company share price rally by 50 per cent since March 2009 lows, but they are still cutting costs and coming to terms with flat to lower revenues. I asked Mentel about this disconnect, but he thinks markets pretty much are in line with where the macro economic data is. Investors tend to forget, a stock that falls 50 per cent has to rise 100 per cent to get back to the levels it started at. When you compare to numbers that were so weak last year, share prices could look a bit frothy. However, as Mentel explains, if company earnings improve 10-15 per cent into next year, then current valuations look fairly valued from current levels. Most companies have had to become very lean and efficient, and the economy is recovering.

Mentel says that while we now only are thinking ahead about the effects of stimulus withdrawal, it will first get really interesting towards 2011 once the withdrawals are felt in the market. He recommends diversifying your assets, and, on the bond side, says it will be crucial to invest through bond managers who can also go short the yield curve.

Joel Stainton, Technical Analyst from SEB futures, says we’re heading towards a stimulus led, tactical upswing, and the FTSE 100 could be close to 6000 by the end of the first quarter.

Louisa Bojesen is a presenter on Squawk Box Europe each weekday morning on CNBC.