2010: a year of questions for investors

Personal Finance One of the worst decades ever for investors is over. Now it's time to try to get a handle on how the next one will unfold, at least early on.

Welcome to the teens, and good riddance to the noughts. One of the worst decades ever for investors is over. Now it's time to try to get a handle on how the next one will unfold, at least early on. Here are some potential developments for 2010 and unresolved issues from 2009 that investment advisers are watching out for. Whether and how they occur could significantly move financial markets or affect your finances in other ways.

Stock and corporate bond markets nearly everywhere soared for most of last year in anticipation of a rebound in economic growth. So far, though, there has been little growth to speak of, and the anticipation goes on. Even with the kitchen-sink stimulus programmes executed around the world, growth remains tepid, although economists and market strategists are convinced that it will soon pick up. The International Monetary Fund anticipates 3.1 per cent growth for the global economy in 2010 after an estimated 1.1 per cent contraction last year.

The Middle East fares well in the forecast, with 4.2 per cent growth projected. That's below the 5.1 per cent foreseen for developing economies but well ahead of the 1.5 per cent increase expected for the United States and 0.3 per cent for the euro area. Many private economists offer higher figures, although they tend to rank the world's economies in the same order. David Kelly, the chief market strategist at JP Morgan Funds, expects US growth of 5 per cent or more.

"I do think the recovery is for real," he said. "All of the cyclical areas got pounded during the recession. That tells us economists that we're about to see job growth. We've seen increases in the average workweek and fewer layoff announcements." The reality is likely to be somewhat better or worse elsewhere, in his view. Europe may grow at 2 per cent, while emerging economies should lead the pack.

But Brian Washkowiak, the director of research for Talon Asset Management in Chicago, considers the economy's difficulty in bouncing back, despite all the help it has received, to be an ill omen. "I suspect the recovery is not going to be V-shaped," he said. "As bad as the economy was, to have it grow [at the pace it did] in the third quarter is not all that great. I suspect it barely grew with the stimulus factored in."

Economic growth may not have recovered to any great extent yet, but investors surely have recovered their nerve after their panic attack took one-half to four-fifths off the value of stock indices during the bear market that ended last winter. But after rekindling the love affair with risk, a renewed flight to safety, even if economies finally get airborne, may be the trend in 2010, some investment advisers warn.

Signs of risk-seeking abound. Bonds whose issuers are thought to be at greater risk of default have been snapped up by investors, pushing their yields down perhaps more than in any other period of market history. The renewed appetite for risk has also been prevalent in global stock markets. Michael Hartnett, the chief global equity strategist at Banc of America Securities-Merrill Lynch, points out that the biggest return last year was in Argentina, a country that had defaulted on its sovereign debt earlier in the decade and whose market had recently been downgraded from emerging to frontier status.

David Wright, the manager of Sierra Core Retirement, a US mutual fund, notes that US stocks trading at less than $5 has greatly outperformed those trading over that threshold and that companies losing money have outperformed profitable ones - until now. "There has been a sea change in attitude toward risk, and I think that's about to change," he said. "The current rally has demonstrated that the gas hasn't gone out of the psychological balloon yet."

Mr Wright counsels risk aversion as he waits for it to come back into fashion. He would stick with high-grade corporate bonds of American and European issuers. ... Including in the Middle East Joe Kawkabani, the managing director for asset management at Algebra Capital in Dubai, likewise advises Middle East investors to be cautious ahead of any rush. That's the policy that his firm has adopted. "As safe investors, we need - not take for granted that the world is on a clear path to recovery," he said. "Our focus is on solid cash cows that will do well in any environment. These are less volatile, less cyclical stocks that will not be impacted should there be a correction." His examples include the Saudi dairy producer Almarai; Mobily, a Saudi provider of mobile phone service; Depa, a Dubai company that furnishes interior fixtures for buildings; and Al Hokair, a Saudi clothing retailer.

If investors do become more risk-averse, it may happen violently or persistently in certain markets. Bubble-watchers identify American commercial property as a sector ripe for a fall, with repercussions for banks and the broader economy. Dubai is another locale, which is expected to experience commercial property woes for the foreseeable future.

"The big shoe to drop is what's going to happen to commercial real estate," Mr Wright, from the Sierra fund, said. "Rents are dropping, values are dropping, loans aren't being renewed." While many stock markets are trading near recovery highs, China has topped out in early August and has made only modest rallies since. Such weakness, after being a standout performer before that, could signal a bubble being deflated. James Chanos, a prominent and successful hedge fund manager, recently told the financial news network CNBC that he was betting big against China ... or in government debt.

Komal Sri Kumar, the chief global strategist at TCW Group, a subsidiary of the French bank Société Générale, finds excesses on some government balance sheets that are big enough to qualify for bubble status. The difficulties in Dubai could mark the initial pop in a widespread sovereign credit crisis, he cautions. "Dubai just happened to be the first shoe to drop," he said, borrowing Mr Wright's metaphor. "It was the luck of the draw. We are going to have several more incidents of this kind in 2010, not just Dubai, but Greece, Ukraine, Iceland, Latvia." The source of the air that inflated the bubble is the stimulus programmes that amounted to a transfer of trillions of dollars of debt from homeowners and banks to state treasuries, he explained. "We have started on a global deleveraging process that doesn't end in one quarter or one year," Mr Sri Kumar said. Eventually, the crisis could hit "the two biggies, the UK and US."

Michael Bapis, a partner at HighTower Advisors, a Florida-based financial-planning firm, also cites the precarious state of government finances. He fears a resurgence of inflation as credit markets go from the frying pan into the fire.

"We've just finished one of the worst global financial crises in the last century," he said. "Economies have been pumped with government money. Inflation is coming with that and there's nowhere to hide in fixed income." George Schwartz, the chief investment officer at Ave Maria Mutual Funds, considers prospects bleak for equities and economic growth for the same reason.

With governments strapped for cash, they may ask you to help them out. Peter McGahan, the managing director of Worldwide Financial Planning in Cornwall, expects UK authorities to raise tax rates on capital gains. British nationals living in the Middle East may believe that they left that unpleasantness behind them with the winter weather, but they may have left some property or shares with accumulated gains, too. It may be wise to cut them loose before a change occurs.

"If they have any assets in the UK, they should consider selling them and utilising the current capital gains tax rules," Mr McGahan said. "It's widely expected that CGT will increase from its current level of 18 per cent to the top rate of tax, which is expected to be around 50 per cent." He also foresees a fresh decline in UK home prices, providing another reason to dispose of property back home.

It's not just state treasuries that are on uncertain financial footing. Sarah Lord, the financial planning director in Dubai for the UK brokerage Killik & Co, points out that banks around the world still have a lot of damage to undo, a process that could put a drag on economies and especially on borrowers. "The cost of mortgages and unsecured debt for consumers will rise across the world, even though [central bank] interest rates are expected to remain at low levels," she predicted.

Higher borrowing costs could help ensure that Dubai real estate values, which have been cut in half in the last year or so, remain low. "A correction in the market was due as prices prior to the global downturn were getting overheated," Ms Lord said. "During the early part of 2010 it is possible that we will see a further fall in prices, maybe as much as another 20 per cent, as supply outweighs demand." A floor in the market is likely towards the end of the year, in her view, as prices reach a level that makes Dubai cheap for foreign investors, compared to other locations.

Returning to her earlier theme, she cautioned: "Much of this is dependent on how much liquidity is available from the banks in the form of mortgages for the investors and capital for the developers."