Fearless stock market predictions made here
David Christianson, CFP, R.F.P., TEP
Here is what is going to happen with the investment markets over the next 12 months.
That got your attention, didn’t it?
In fact, we will hedge a little, and outline several scenarios for the direction of the stock and bond markets over the next year, based on different developments in the economy.
(Sorry folks, that’s the best I can do - if I could really predict the future, then I could retire from my day job and write for the Free Press full time…)
The economy is in better shape than it was six months ago, especially from a psychological and confidence point of view. While unemployment is still high and layoffs are still occurring (but at a much slower rate), some industries are hiring again, recent corporate profits have beaten expectations, borrowed money is more available than last spring and real estate markets are strengthening.
Sounds great, but there are also a bunch of negatives and hurdles to overcome. This week, stock market investors remembered those, and sold stocks to capture some of the profits they may have made in the last seven months. But this article is about the future, not about the past week.
Last winter, it looked like a global financial and economic meltdown was possible. Stock prices - and even the prices of corporate bonds and preferred shares – reflected this expectation of depression, rather than recession. In fact, the pricing of such investments factored in the assumption that corporate bond defaults would be worse than those that occurred in the Great Depression.
Thanks largely to coordinated government action, these dark scenarios did not occur.
With the benefit of hindsight, we know those extreme fears were largely unfounded. Even at the time, many of us felt those fears were exaggerated, and that stock and corporate bond prices represented historic bargains.
That proved to be correct, and immense gains have been seen since the bottom in early March.
However, with the stock markets up some 50% since then, it’s clear that such easy profits are no longer available. Stock markets are now close to fair and the yield spread between corporate bonds and government bonds has returned closer to historic norms.
The prices of stocks and bonds at any one time reflect the collective view of investors about the future of the economy, interest rates, corporate profits and inflation, and investors’ willingness to take risk.
In early 2008, investors were fearless, to the point of recklessness. Last September, they were reminded of risk and, as the markets plunged, fear returned and increased, until investors ran from everything except government bonds and, ironically, the US dollar.
So where are we now?
From Here
That extreme fear has gradually diminished, and the risk premium that investors demand is now at a more historically normal level.
The investment markets – the collective minds of investors – seem to believe that the world economies are recovering, that 2010 will be a year when we return to economic expansion, that interest rates will stay low for the foreseeable future, and that inflation will stay low for a while, but could still be a danger within a year or two.
If the markets are exactly right, then you can expect normal returns on stocks going forward, some speed bumps along the way (like the past week) and low returns on government bonds.
Variables? 1) If inflation heats up or if interest rates start to rise faster than expected, government bond returns may be negative. That will shock a lot of risk avoiding investors. (In this scenario, stocks will probably do well, as it is based on a faster-than-expected economic recovery.)
2) If we slide back into a double-dip recession, stocks will get walloped and bonds will rally.
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David Christianson is a fee-only financial planner and investment counsel with Wellington West Total Wealth Management Inc. His column, ‘Dollars & Sense’ appears Fridays in the Winnipeg Free Press.