Economy Will Drive Stocks in 2010; Part 1 of 2

“Calling the Trend” Column, by George Leong, B.Comm.

The year 2009 returned the best performance since 2003 and reversed a bear market in 2008 and several years of lackluster results. At the beginning of 2008, there was buying emerging in January that, based on the historical data, pointed to an up year in 2009. The results in 2009 were far better than what I had expected, especially during a recession.

The technology sector was the market driver and leader throughout 2009, and I will later talk more about why I feel technology will continue to be the leader going forward. The NASDAQ is up about 41%, while the small-cap Russell 2000 gained 24%, the same as the S&P 500. While the returns were impressive, they paled in comparison to the 72% rise in the benchmark Shanghai Composite Index (SCI). I feel that China and Chinese stocks listed on U.S. exchanges will continue to provide top growth opportunities going forward over the next five to 10 years and more. I will discuss more about China later in this article.

As we enter 2010, watch for what happens in January: what is referred to as the “January Effect.” Historically, what happens in January does help to influence and foreshadow how stocks behave going forward.

The situation at this time is far better than what it was a year ago. The U.S. is recovering from its recession along with the global economies. The signs in the U.S. economy have been encouraging and positive, but there will continue to be issues with the distressed housing market, where we have seen a major loss in property wealth, and the continued weak jobs market, where Americans continue to lose jobs.

The past year had been characterized by encouraging news in the banking sector along with GDP growth, which marked the end of the recession.

We also continue to witness more positive news from the troubled housing sector. The construction of new homes jumped 8.9% in November, with the 574,000 units coming in marginally weaker than estimates, but the number of new building permits jumped six percent to a better than expected 584,000 units. Sales agreements for home sales in November was stronger than expected and at its highest level since March 2006, but the ISM Index expanded at a lower than expected rate in November. The positive is that the ISM continues to point to manufacturing activity improving, which is what is important at this time. Again the strength is the concern.

The housing data are positive, as housing is a key area along with jobs, which need to strengthen in order to give the economic renewal some support. We need to see home prices rise in order to help drive consumer confidence, spending, and economic growth. Consumer spending accounts for about 70% of GDP growth, so you can see the significance here.

In the jobs market, the key non-farm jobs report fell by a mere 11,000 in November, much better than the 125,000 estimate. Moreover, the unemployment rate fell to 10.0% from 10.2%. The private ADP Employment report was weaker than expected with, the loss of 169,000 private jobs in November, an improvement over the 203,000 lost in October, but worse than the estimate of 150,000 job losses. The positive spin in this is that it would be the eighth straight month of lower job losses. Improving jobs means increased confidence and could lead to higher spending and GDP growth. The data make for very positive news, but, again, we need to see this continue in December 2009 and in 2010 with job gains. Should this happen, it would really give the market a boost heading into 2010.

As far as the economy goes, at the final Federal Reserve FOMC meeting of the year, the low-interest-rate policy was maintained in an effort to allow the economy to continue its rebound and the Fed said it would keep interest rates low for an extended period of time. The Fed also said it would begin to halt emergency funds as the economy improves, which is adding some concern that it would slow the stimulus-driven recovery that we have seen. This is an important factor that must be watched for in 2010. Any signs of renewed slowing must be met with further stimulus spending. The Obama administration cannot let its guard down now.

I feel that trading in 2010 will continue to be based on the strength of the economic renewal in both the U.S. and abroad. Federal Reserve chairman Ben Bernanke suggested that the U.S. was facing “formidable headwinds” that could impact the strength of the recovery and added that interest rates will be maintained at the record low for an “extended period.” Good for financing, but bad for the economy.

At the monthly Beige Book address, the Fed was upbeat about the economy and the low inflation, which will likely allow the Fed to leave interest rates near zero into 2010. The concern is that saying rates may stay low suggests that the economy is not growing fast enough and could face more hurdles. This is what is concerning traders. The market is pricing in stronger growth, so there could be some issues in 2010.

On the inflation front, the PPI for November was slightly stronger than expected. The more important CPI, excluding food and energy, for November was flat versus estimates calling for a slight rise. This is positive for interest rates and allows the Fed to maintain its loose monetary policy.

In the banking sector, despite the risk still prevalent with their weak balance sheets and credit that’s bad, there has been some optimism that the sector will continue to strengthen. In spite of over 100 banks closing, the larger national banks continue to try to reverse. We are seeing many paying back their TARP funds and hence getting rid of the government influence and management.

Retail Sales for November were better than expected, with a rise of 1.3% versus the estimate of 0.6% and an increase from 1.1% in October. The reading was positive, but we need to see the positive trend develop in December 2009 and in 2010. There could be some spending issues after a CNN/Opinion Research poll indicated that Americans will cut their spending during this holiday season. I sense that consumers are waiting for deeper discounts before buying non-essential goods, which could hamper the retailers’ margins.

Oil continues to edge higher towards $75.00 a barrel, as OPEC meets this week. There is speculation that the OPEC oil cartel will likely leave production unchanged. OPEC is said to have no problem keeping oil at the $70.00 to $80.00 range. In theory, major production cuts would increase prices, but also kill the global economic recovery and hence drive demand down. OPEC does not want this.

Happy New Year! Here’s to another year of great money opportunities.

Part two of this article will appear in the Wednesday issue of PROFIT CONFIDENTIAL.