The market’s flat performance year to date shows that it has lost the momentum from its spectacular run last year. This lack of conviction and direction (even in the face of a growing economy and strong earnings) may seem puzzling.
But is it? My short answer is: No, it’s not puzzling.
My goal here is to help you make sense of it all and give you a few investment ideas along the way to profitably navigate this market environment.
Compared to the turbulence of the last two years, I envision 2010 to be a fairly tame affair, with the major indices up a decent but unspectacular 5% to 10%. I see the year as one of stability and consolidation, both in the equity markets as well as the underlying economy.
Keep in mind that this outlook is not inconsistent with periods of weakness, as we have seen recently, followed by stagnation and/or positive gains.
Not every sector and every stock will be stuck in such a tight range. There will be plenty of winners and losers along the way. And if you stay with me a bit longer, I will give you the framework to identify them for yourself and have a very profitable year.
Why a Range-Bound Market in 2010?
Last year’s impressive performance reflected the realization that we were not headed towards the Great Depression 2.0. It was the exit from the recession and the above-mentioned recovery that was fully priced in by last year’s market run up ahead of time.
While the very long-term trend remains favorable, there are many rational reasons for the market to take a pause now before making a clear trend move. Here are some of them:
- Double-Dip Fears: The market needs to be reassured that the recovery is sustainable and that we are not going back into another recession. The fear is that as the fiscal stimulus wears off in the second half of the year, the growth momentum would be difficult to sustain.
- Labor Market Concerns: As February’s Employment Situation report showed, the labor market remains in a very precarious state. Everybody is talking about a jobless recovery, but how strong can the overall recovery be if we continue to have massive labor market slack?
- Fed Policy: Closely tied with these issues is the Fed’s eventual removal of the extremely stimulative monetary policy measures that it put in place in the downturn. With respect to interest rates, the Fed has been saying for a while now that it intends to keep interest rates low for an ‘extended period’. The market is actively engaged in handicapping a timeline for the Fed to raise rates; not exactly an easy exercise.
- PIGS & China: As if these domestic issues were not enough, the market also has to contend with sovereign risk issues and moves by China’s central bank. While fears about the sovereign debt profile of Greece or any of these other countries (the so-called PIGS – Portugal, Ireland, Greece, and Spain) have receded to some extent, China remains a major issue. China is trying to control some of the speculative excesses in its real estate sector – in essence it is trying to let the air out of a bubble without actually popping it. China’s ability to pull that off without damaging its economy is far from certain and remains a key risk factor for the global economy.
While all of these issues are real and substantive, I do not foresee any of them, individually or in combination, derailing the current ongoing recovery. I remain confident of the sustainability of the recovery and see enough evidence on the ground that the economy can sustain the growth trajectory even as the stimulative crutches are removed. That’s the reason I am forecasting a positive gain for the market, albeit a small one compared to last year. It is the collective weight of these concerns that is expected to keep the market in check.
How to Make Money in a Range-Bound Market
It is easy to make money in a bull market – everything goes up, including the lowest quality and riskiest stocks. But don’t let the market’s rising tide lull you into believing in the invincibility of your stock-picking prowess. That is one trap that you need to be aware of in this market environment.
You don’t need to be a professional to make money in this market. But make sure you understand that what worked last year is pretty much of little value at this time. You can still find winners out there, but you need to do a bit more due diligence to identify them.
While such winners have many attributes, three really stand out – Earnings Growth, Quality, and Valuation.
- Earnings Growth: The most important attribute of a winning stock is its earnings growth profile. But just plain vanilla earnings growth is not enough to push the stock price higher. Current consensus earnings expectations already capture the company’s growth prospects. It is more about the potential for the stock to grow above current expectations that really make the stocks soar. The Zacks Rank helps you capture this key growth potential attribute. At any given time, stocks with a Zacks #1 Rank offer the best earnings growth profiles of the entire market.
- Quality: Quality has its subjective components, but I am referring to the quality of the company’s: product/service, financial health and management. You want to invest in a company that enjoys a competitive advantage in its product/service market, is in strong financial health and is led by a proven management team. There is nothing subjective about any of these attributes.
- Valuation: If all the positives about a company are already out there in the market, then you may have already missed the bus. How can you tell if that is the case? Looking at the company’s valuation multiples, such as price-to-earnings (P/E) or price-to-book (P/B), and comparing those to its peers should give you a good idea of relative valuation. Buying a quality stock at a discount to its peers is as good as guaranteeing an above-average return.
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Best,
Sheraz Mian
Sheraz is the Director of Research at Zacks. He oversees all the stock analysts who provide insights and stock reports through Zacks Premium.
