Association for Investor Awareness - Week of 01/14/2010

In This Issue:

The 2010 Economy May Be Stronger Than Expected
The Bull Market Should Have Longer Legs
Our Recommendations Remain Very Attractive
Earnings, Earnings, Earnings!
Interest Rates, Interest Rates, Interest Rates!
Stick With Short-Term Bonds & CDs For Now
Rental Real Estate Is Starting To Look Good Again
The Bottom Line This Week

Last year the stock market reminded us of a Phoenix rising from the ashes. After suffering a devastating 18 month slide, stocks began to rebound on March 9. By the time the closing bell for the year rang on December 31, the Dow and the Nasdaq were up 18.8% and 43.9% respectively. How nice it was!

It is instructive to notice that most of the market's gains occurred while the economic outlook was especially bleak. In fact, stocks started to turn back up at the same time several economists said the outlook couldn't be worse.

Savvy investors, of course, realized that if the economy could not be worse then the slide must be over. Additionally, any change from "worse" could only be positive. As we reported at the time, smart money was starting to buy stocks, and the rest -as they say- is history.

The 2010 Economy May Be Stronger Than Expected

During the depths of the Great Recession we advised our readers that the U.S. economy would improve this year. Now it appears the rebound may be stronger than expected. Instead of the 2.8% growth that seemed likely, we may see as much as 4% or slightly more.

The factor that took nearly everyone by surprise is consumer spending. On the face of it, Joe and Sally MidAmerica should not be able to spend much money. House values are down as much as 50%, millions of credit cards are maxed out, debt levels are high, and workers are still being laid off right and left.

Nevertheless, consumer spending is stronger than expected. For example, retailers expected Holiday sales would be abysmal. Instead, they were up about 4% overall. Since consumer spending is two thirds of the economy, the numbers point to at least a moderately good year.

We are not suggesting that the U.S. will see anything that might resemble a boom. In addition to the negatives we just mentioned, there are also concerns about rising inflation and interest rates. Nevertheless, for at least the first half of 2010 the overall outlook is more encouraging than it appeared to be as little as two months ago.

The Bull Market Should Have Longer Legs

Despite the better than expected economic outlook, many analysts are saying that the bull market in stocks has run its course. The more pessimistic among them believe the run-up was little more than a giant-sized dead cat bounce after a deep market slide. Many analysts also believe the bear market may have several years to run.

We think the naysayers are wrong in thinking the bull market is over. Although the easy gains may have been made, there should still be good profits this year as companies begin to benefit from what is shaping up to be at least a partial worldwide economic recovery.

Our Recommendations Remain Very Attractive

In recent issues of this newsletter we recommended several stocks we expect to do very well this year. If you didn't save the list, here it is again:

For An Emphasis On Capital Gains:

Alcoa (AA)

Deere & Company (DE)

Caterpillar (CAT)

Coca-Cola (KO)

Colgate Palmolive (CL)

Exxon Mobil (XOM)

General Electric (GE)

Goldman Sachs (GS)

Johnson & Johnson (JNJ)

Procter & Gamble (PG)

Wal-Mart Stores (WMT)

For An Emphasis On Current Income:

Consolidated Edison (ED)

Eli Lilly (LLY)

Kinder Morgan Energy Partners, L.P.

Earnings, Earnings, Earnings!

The key to a continuing stock market rebound will be improving corporate earnings. Thus far, investors have been willing to bid stock prices up on faith. Soon, however, investors will want to see confirmation that their expectations were correct.

We think that milestone will be reached this quarter. At that point, stocks can advance to the next level before they pause again for another appraisal. The two step process should at least carry us through to the middle of the year.

Interest Rates, Interest Rates, Interest Rates!

In addition to watching corporate earnings, investors will keep their eyes on interest rates. As everyone with fixed income investments knows only too well, the Fed has been keeping interest rates on the floor to help the economy recover.

At the same time, the Fed has been stimulating the economy by flooding it with money. So far, most of the funds have gone to banks that are holding onto them until they feel comfortable making loans again. Once the Fed's money gusher starts to flow into the general economy, we will almost certainly have higher inflation. Nobody knows when the process will begin and how big the problem will become – but it's coming.

Mr. Bernanke at the Fed is well aware that a new inflation cycle will be a threat to growth. To help keep inflation in check he will need to raise interest rates. But, if rates are pushed up very much, the economy will suffer.

The bottom line is, the Fed must manage interest rates very carefully over the next few years. That's a tall order. As one anonymous Fed official said recently, "Everybody wants us to fine tune the economy, but the only tools we have are a blowtorch and a sledge hammer."

We will need to watch this situation very closely as the year unfolds. For the next few months, however, we don't expect any big surprises.

Stick With Short-Term Bonds & CDs For Now

With interest rates poised to move up, the last thing you should do right now is buy long-term bonds or CDs.

Instead, stick with short-term fixed income investments and plan to roll them over as rates increase. When rates finally peak you will want to go back to long-term bonds and CDs. But that point may be a year or more away.

Rental Real Estate Is Starting To Look Good Again

Speaking of interest rates, in many cities rental housing may once again be a good investment. Not only are mortgage rates low, prices have fallen so far that for the first time in nearly 20 years, properties can "pencil out." That is to say, the rents they generate will cover the mortgage payments, taxes and maintenance costs – plus provide a positive cash flow to the owner.

The tax breaks that go with real estate investments —and the potential for long-term appreciation from today's depressed levels— make real estate even more attractive. In addition, the collapse of the late great housing boom is pushing many new people into the rental market, and suitable properties are often in short supply.

Critics say that it may be a decade or more before residential real estate gets back to where it was during the boom. We agree. However, you won't need a full recovery to make excellent profits. Thanks to the leverage in most real estate investments, only a partial recovery could still double your money.

For example, a nice duplex that was $300,000 three years ago may be available in your area from a "motivated seller" for $200,000. With today's tighter credit requirements, you would typically be asked to put up $40,000 (20%) to buy the property. If the duplex appreciates to $240,000 within a few years, you will have a 100% profit (less expenses).

Of course, residential real estate prices may continue to decline in many markets. But with prices down from 25% to 50% already, and with buyers starting to come back, the bottom can't be far away even in weak areas.

However, let's assume that the price of your $200,000 duplex slips 20% to $160,000 – and it never comes back (which seems very unlikely). In that case, you will lose your $40,000 down payment.

Nevertheless, if the duplex penciled out when you purchased it, your renters will pay the mortgage and leave with you with $160,000 in equity. That's still a nice profit. And that doesn't include all the fun you will have fixing the roof and pumping the septic tank.

The Bottom Line This Week

The economy is no barn burner, but it appears to be stronger than expected. Ditto for corporate earnings. Meanwhile, interest rates remain low. The combination should be a recipe for higher stock prices in 2010. Residential real estate is also starting to look attractive in many cities.

Until Next Time

The AIA "Advocate For Absolute Returns", a publication of The Association for Investor Awareness, Inc., tracks market trends, industry news, the SEC, global trade and finance and Washington developments for you because they affect your investments. But who doesn't? Many sources report these issues as abstract facts. We feel that's not enough. The AIA Advocate's job is to warn you of what's important and how these developments translate to ground-level forces and threats that directly affect your wealth as well as your current investment opportunities. Not just information, but information you can use. Until next time ...


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Posted 01-14-2010 9:57 AM by Research & Editorial Staff