The global equity market is likely to take on a U-shape — for uncertainty — in 2010.
Uncertain corporate profits, fragile global growth rates and concern over how governments will exit from liquidity programs all create big question marks for this year's markets, experts said.
“The strong performance in 2009 was driven by macro factors, higher than expected corporate profits, bargain-level valuation and liquidity. All of those factors created a good cocktail for the marketplace,” said Simona Paravani, global investment strategist for HSBC Global Asset Management based in London. “Going into 2010, liquidity continues to be a plus with interest rates remaining low (in developed markets). But as far as the other three factors are concerned, we are more cautious.”
The biggest unknown on the policy landscape centers on how governments around the world implement exit strategies from the unprecedented liquidity injections, according to several consultants. If policymakers are too early, the fledgling recovery could stop in its tracks. However, too much liquidity for too long could result in runaway inflation.
“We think (policymakers) are very much committed to reflation,” said Tim Drayson, economist at Legal & General Investment Management in London. Governments in developing nations “still fear deflation much more than inflation and that means keeping interest rates exceptionally low right through (2010).”
Another key consideration for markets in 2010 will be the level of economic growth and corporate earnings. “I think that (most economists) have conceded that this will be a below-average recovery considering that it has been such a severe recession,” said Richard B. Hoey, chief economist at BNY Mellon Corp., New York. “However, I do believe firmly that we do have sustainable economic expansion.”
For the rally in global equity markets “to progress from here, it's going to be all about the earnings,” said Richard Mathieson, London-based senior investment strategist in the scientific active equity division at what was formerly Barclays Global Investors, now BlackRock Inc.
While 2009 was marked by “positive surprises” in corporate earnings because of severe cost-cutting measures and low expectations at the beginning of the year, 2010 could potentially have the opposite effect. Pretax profits are estimated to rise around 25% on a global basis in 2010.
“I'm concerned that the possibility for negative surprises to emerge hasn't been factored into the (equity market) rally,” said Carl Hess, global head of investment consulting at Watson Wyatt Worldwide based in New York.
For example, credit is still restricted for small to midsize companies, several consultants said. Unemployment remains a concern, particularly in the U.S., where it is expected to hover around 10% at least through the first half of 2010. “Where's the growth?” Mr. Hess said. “We can talk all we want about building inventory, but if consumption lags, so does the GDP.”
Furthermore, companies are running out of cost-cutting options to boost the bottom line, several consultants and managers said.
“Aggressive cost cutting in Q1, Q2 and even Q3 — especially in the U.S. — has meant that corporate margins have generally been better than anticipated,” said Rekha Sharma, global strategist at JPMorgan Asset Management based in London. “That can only go so far, because companies can't continue to cut cost much more without fundamentally harming their businesses. They need revenue and sales to expand; this will be a key concern going forward.”
The direction of the U.S. dollar in relation to the euro, yen and major emerging market currencies will be a key issue in determining investment inflows on a countrywide or regional basis, said Andrew Milligan, head of global strategy at Standard Life Investments Ltd., Edinburgh. If the dollar rises in relation to the yen and euro, more money could filter into Japan and the eurozone because their securities would be relatively cheaper. However, a rise in the dollar could also depress commodity prices, which would have an adverse effect on certain economies, including certain emerging markets that rely on commodity prices for growth, he added.