Early In The Year, And Already Surprised

¹²Early In The Year, And Already Surprised

By Paul J. Lim, MoneyMag | 20 February 2010

After last year's stunning rally in global stock markets, many investors thought they knew what to expect in 2010. Among their bets were that the worst of the credit crisis was over[!?!] that the global economy would continue to expand and that the dollar would remain weak as economies abroad were expected to grow faster than that of the United States. What's more, if anything was to derail the new bull market, it was the likelihood that government efforts to jump-start the global economy would fan the flames of inflation.

Now move to the present. Less than two months into the new year, many of these assumptions are already under fire. For starters, economic turmoil overseas, spearheaded by a crippling debt crisis in Greece [[as well as the other PIIGS, Iceland, the UK, Eastern Europe, : normxxx]], is leading to new doubts about the global recovery. Even if Europe doesn't fall into a double-dip recession, some economists fear that the region won't fully recover until 2012.

As a result, investors have been selling euro-denominated investments and buying the dollar, raising its value by around 6 percent against the euro so far this year. The surprising events prove a couple of important points, market strategists say. First, they highlight the risks investors face whenever a strong consensus forms around any market call. "There's an old saying that goes, 'if everyone is forecasting something, then you know it won't come true,'" said Sam Stovall, chief investment strategist at Standard & Poor's.

Second, more often than not, he said, it's the thing that investors don't see coming that ends up unsettling portfolios. After all, at the end of 2009, how many people worried that the Greek debt crisis would stall the new bull? Third, and more important, the issues that are scaring the market today "show that our assumptions about the financial crisis being over are premature," said Charles de Vaulx, a portfolio manager at International Value Advisers.

At the core of the recent global credit crisis, he noted, was the dangerous amount of risk that individuals and corporations assumed by borrowing to spend and invest. And, he said, "the way this crisis has been addressed around the world has been through a huge amount of fiscal stimulus". In other words, to keep the economy afloat while the private sector repaired its balance sheet, governments worldwide picked up the spending slack. "But the result of all those actions is that now, suddenly, the focus is on the creditworthiness of governments themselves," he added.

That means the fiscal actions around the globe didn't end the credit crisis. They merely shifted the focus to another segment of the economy: the public sector. Does this mean that the rally— and the recovery— are over? Not necessarily, market watchers say. But at the least, it's a sign the market may have gotten ahead of the underlying economy.

Ernest M. Ankrim, senior markets adviser at Russell Investments in Tacoma, Wash., said that after stocks soared nearly 70 percent between March 9 and Dec. 31, as measured by the total return of the S.& P. 500, investors were probably betting on an economic rebound that would be as good as the downturn was bad. But Mr. Ankrim noted that the markets might have miscalculated in one crucial area. After suffering through recent troubles in the housing, equity and job markets, he said, consumers aren't likely to go back immediately to their free-spending ways.

That, in turn, could slow the economic recovery both at home and abroad. This would seem a strong argument to bet against the economies of the United States and Europe and to bet on the much more rapid growth of emerging markets. But not so fast. Just as the developed economies surprised investors negatively early this year, they could just as easily surprise on the upside later in 2010.

Consider the euro. While its decline reveals real problems in Europe, it could also create a tailwind for some of its markets, said Michele Gambera, chief economist at Ibbotson Associates. He noted that while Greece faces major budget problems, the economies in Germany, France and the Netherlands are in far better shape. Yet the fall in the euro caused by Greece's problems could lift the exports of those healthier countries, whose products would thus be priced more competitively, he said.

Investors who are thinking of betting on the emerging markets should also take note of another surprise this year. Although emerging economies are growing must faster than the developed world— growth in China, for instance, is projected at nearly 10 percent this year, versus 2.6 percent in the United States and 1 percent in Europe— many emerging-market stocks have fared just as poorly as Western European shares lately.

Chinese stocks are down about 7 percent this year, on average, about the same as European equities. The average Brazilian stock has lost more than 6 percent. But that's what often happens in markets where investors are prepared for one scenario, but where another one unfolds. "If you don't expect something to happen and you haven't prepared for it," says Mr. Stovall of S.& P., "that's when panic often sets in."