2009 was a great year for world markets. The Dow rallied close to 20% over calendar 2009, whereas the ASX200 was up over 30%. Of course if you measure the gains from the bear market low you see gains in the vicinity of 50%, which is truly phenomenal for a 9 month period.
The lion’s share of these gains was due to the market correcting from a severely oversold position. In early 2009, shares were being priced for Armageddon with most stocks trading at very low valuations. Once the market realised that there was a dramatic disconnect between share prices and likely earnings, things quickly corrected back to more reasonable levels.
Justification for this has been provided by economic and corporate data, which for the most part has come in above expectations. However, now that the market has corrected the apparent imbalance between earnings and share price, gains of a similar magnitude are extremely unlikely without a corresponding improvement in financial performance.
Nevertheless, reasonable gains are likely if indeed we do see signs of continuing recovery. This means that the next round of company results are critical in setting the tone for 2010. However this time round the market is approaching reporting season in a much more optimistic frame of mind. While confidence is always a good thing for markets, it does however lessen the potential for significant upside surprise. Indeed, it means there is a greater downside potential. Should results fail to live up to the market’s improved expectations, it is likely the first half of the year will be difficult for investors.
What is equally important is the outlook offered by companies. Ideally we will not only see businesses meet expectations, but also offer attractive, or at least positive forecasts. My feeling is that, on average, most stocks will report results largely in line with expectations. As for their outlook, caution will most likely be the dominant theme, with companies stressing that while there are tentative reasons for optimism, significant risks remain.
Should this view be proven correct, we are likely to see the modest gains for the first half of 2010. If not, barring widespread and significant disappointment, the market will most likely track sideways. In either event there is still good reason to be invested in the market, provided one takes an income focus.
With share prices still well below their all time highs, dividend yields are for the most part extremely attractive. Given that rates remain at historic lows, especially in the US, it will be difficult to find another asset class that can offer such attractive income potentials. While the next major leg up could be a distance away, at least investors will be rewarded in the meantime.
Make the markets work for you!