Where the smart money should be heading next year

Kathleen Brooks
AT THE start of 2009, there was a very real chance that we would enter another Great Depression and the banking system was still on its knees.

But the past 12 months have been an astonishing year in the markets – stock market indices have risen sharply beyond all expectations and major countries returned to growth as early as the second quarter of the year.

So after such a momentous period, what will characterise 2010? We asked nine of the City’s analysts to give their views about what next year will hold for the markets. While there are plenty of differences of opinion, they all agree that returns will be much lower than in 2009.

Emerging markets will be the big story of 2010 as developed countries continue to battle budget deficits and below-trend growth. But don’t be tempted to lump all emerging economies together – their diversity means a “one size fits all” trading strategy will not work.

And in the UK, uncertainty about the general election is expected to dominate the markets in the early part of the year, affecting everything from equities to bonds. Expectations for withdrawal of monetary and fiscal stimulus packages will then start to play a greater role in the markets.
In this uncertain and still volatile environment, caution should be every trader’s watchword as they look to play the markets in 2010.

Market strategist, City Index
The big question for 2010 will be the timing of the removal of stimulus packages in the US and UK. The markets now expect the Bank of England to make a statement about ending quantitative easing when it next meets in February. But the BoE and other central banks around the world need to be careful. At the moment markets are bullish because of low interest rates and stimulus measures, which make money cheap. If any one of these supports is withdrawn too early it could lead to a further bout of risk aversion.

The strength of the US dollar is another big story for 2010. If the Federal Reserve starts to look hawkish (in other words like they will raise interest rates) this could put pressure on the dollar to appreciate. A stronger dollar could weigh on commodities, which in turn could hurt mining and mineral resource companies in the UK.

Although there is a risk there could be more fallout from the credit crunch, such as in Dubai three weeks ago, as long as individual events remain stand-alone there is nothing to suggest that, at this stage, such events could have lingering effects.

Senior trader, WorldSpreads
The general election is the major event risk of 2010, which could be significant for the Bank of England. The Bank has not been independent for the last year, but if it gets back its autonomy (if there is a change of government) then the BoE has hinted that it will be keen on raising interest rates, which will be significant for the pound.

In the first six months of the year the euro could benefit from economic weakness in the UK and reach parity with sterling. This time there is a greater chance it will stay there.

We think the FTSE 100 could get up to the 6,000 mark next year. In the last six months the FTSE has traded on low volumes, but I think fund managers will want to be more fully invested next year, which could push the index to new highs.

2010 could see some consolidation in the mining sector. Large mining companies have cut back on R&D spending during the recession so they will look to snap up smaller rivals with proven reserves to boost their own stocks.

The retail sector also looks like it could be under pressure next year and we could see some more companies fail. Weak Christmas sales could be the catalyst.

UK strategist, Morgan Stanley
The UK economy has shifted from being NICE (Non Inflationary Constant Expansion) to GRIM (Growth Really is Mediocre.) Although the global economy is making quite a good recovery we think the UK will only limp back to life relative to its peers due to our economy’s reliance on construction, financials and the public sector, all areas that could suffer in this environment.

Weaker growth will weigh on the FTSE 100, and we think it will fall to 5,000 by December 2010.
You need to be more defensive in these circumstances, what you want to do is sell financial stocks and buy defensives, you also want to be exposed to stronger growth in emerging markets and to be wary of stocks that are too reliant on developed countries.

Commodities are still attractive, which should benefit BP. The oil major will also gain from weakness in sterling as it earns in US dollars.

The biggest risks for 2010 are that bond yields will shoot up higher than people expect, potentially up to 4.5 per cent.

Economist, Capital Economics
In terms of the macro outlook it’s very difficult to come up with a general theme for emerging markets next year. Instead there will be divergences with Asia performing strongly, Latin America somewhere in the middle, and emerging Europe lagging behind. Although Poland and Turkey look in good shape there is real concern about Latvia and some of the Baltic states.

Our forecast is for the dollar to rally and commodities to fall. This could have a big impact in Latin America, especially for Venezuela, which has an economy heavily reliant on energy. A weak oil price could devalue the bolivar.

The biggest risk for emerging markets next year could be the banking sector in central Europe. In other crises there has been a problem with public debt. This time private debt is a problem and for Hungary and Bulgaria especially. Their woes were caused by a rapid pace of credit growth, especially credit denominated in foreign currencies. Banks in Sweden, Austria and Belgium are all exposed to a banking crisis in emerging Europe and this risk will not disappear in 2010.

Head of sales, Capital Spreads
The concern surrounding the UK’s AAA credit rating will linger in 2010 since the Chancellor’s pre- Budget Report (PBR) didn’t offer any clear ideas as to how we will address our fiscal difficulties. That means we will continue borrowing vast amounts until at least the general election next year. The longer we wait for the election the more it could affect our credit rating.

If we are downgraded, then that will cause a whole world of worry like it has in both Greece and Ireland. It would also mean that our debt servicing costs would spiral and it would also cause sterling to struggle against a number of other currencies.

Another theme for next year is the US dollar. We have seen the dollar perform inversely to stocks for most of this year, so when stocks go up the buck has been falling.

But there are indications that this correlation is breaking down, which is positive for the dollar. This could leave sterling exposed not only to a downgrade but also to a stronger greenback. The euro and the yen would also be impacted.

Head of treasury, Europe Arab Bank
We are certainly not out of the woods just yet so the outlook for 2010 for me would be one of caution. I think that commercial real estate will be a real flash point to be wary of, partly because banks still have a lot of exposure to this sector. Western governments will maintain their monetary and fiscal stimulus, at least for the first half of the year, so I don’t expect that interest rates will rise any time soon.

And as equity markets have been marching higher, Treasury Bill rates have been dropping. This is a complete paradox that we don’t normally see in the markets and it is definitely a big pointer for caution in 2010. I don’t see any major developed economies growing at speed next year and we are likely to be bumping along the bottom for at least the first half of next year.

Regardless of which asset classes you are invested in or considering taking out positions in, these macroeconomic factors will all play an important part in determining how the markets shift during the next 12 months. It is therefore clear that you will need to exercise due caution and watch developments closely.

Head of fixed income research, Evolution Securities
I think fixed income is going to be the most important asset class in 2010 and it will also drive how other asset classes perform because there is one big question for next year – will governments continue to be able to borrow at a reasonable rate and in sufficient quantities to satisfy their liquidity requirements? If they can, then this will form the basis for equities and other risky assets to do well. But if they can’t, then carnage could ensue. If this is the case, then every other asset class will also suffer, with perhaps the exception of gold, tinned food and defendable land, which could survive an armageddon
However, there is no immediate concern for governments that need to raise plenty of cash, as they are likely to be able to tap the markets for what they need next year.

But while this year has seen extraordinary returns, 2010 is likely to see a steadier performance in the credit market. We are likely to see some weakness in government bond prices and we think that the credit spread will probably tighten between 30 to 40 basis points over the course of 2010, but the range of outcomes is so broad that it is difficult to say.

UK director, Charles Schwab
We expect the recovery – in both the economy and the market – to be square root-shaped. The big question for 2010 for US stocks will be whether growth can be sustained when monetary and fiscal stimulus is scaled back. In our view interest rates are likely to rise much sooner than people are expecting because the economy is past the worst and low rates cannot be justified for much longer.

In terms of sectors of the US stock market, we have reduced our exposure to more cyclical stocks such as base materials and industrials. These tend to do well at the beginning of the rebound but we are definitely past that point now. Consumer demand is improving in the US so we are now neutral on consumer staples and telecoms, which should continue to perform well over the next year. But our preferred sector – and it has been for a while – is information technology. Lots of businesses have held back on their technology spending during the recession but as conditions improve, this should open the flood gates. Also, companies will be trying to squeeze as much productivity as they can from their employees and IT investment is one way to do this.

Market strategist, CMC
The big story of the year will be the general election. The markets usually ignore political stories and we should see the same in this case. However, the prospect of a hung parliament could leave the major markets nervous ahead of any result.

The problems of British Airways have been well documented in recent months. It is hemorrhaging cash, a loss of £400m last year alone, and has a pension deficit of £3.7bn, which could scupper its prospective tie-up with Iberia. Whatever your views on chief executive Willie Walsh, and his ham-fisted attempts to cut costs, you don’t need to be a genius to work out that for the airline to survive it needs to make these cuts.

Then there’s the situation with Cadbury. I expect to see Cadbury remain an independent company, as the situation with Kraft Foods looks beyond repair and quite frankly Kraft doesn’t have the cash. The only other prospect is that of a tie- up with Hershey but with Cadbury bosses reassuring shareholders with a positive outlook and profit numbers, then independence looks the favourite option.