Monthly Market Commentary 2010 Royal Bank of Canada

2010: The Bull Market Continues

Last January’s commentary was titled “2009: The Birth of a New Bull Market” and was an attempt to refine the facets of a broken financial system on life support, profoundly negative investor psychology, and an uncertain economic outlook into a message investors might use to enable anticipation rather than captivation by a painful rear view. Little did I suspect then that a tsunami of margin call induced hedge fund liquidations that would create what I believe will prove to be a generational bottom. Since that March low the market has rallied, has not looked back, and I do not believe it will in 2010. Here is why…
The market is not overpriced, and many quality market-leading companies trade cheap to the market. According to a recent Barron’s analyst consensus, the S&P 500 P/E ratio of 14.4 times the $77.48 2010 earnings estimate represents a significant discount to the 16.3 times historical average. By my count, 11 Prime Opportunity List stocks trade at a price-to-earnings discount to the market P/E for 2010. In point of fact, the average U.S. blue chip now trades at a discount and often features a growing dividend yield that is competitive with a fixed 10-year Treasury yield. Cost cuts and mindful pruning of overhead has created a condition featuring operating statements levered to drive outsized profit on any revenue increases. Now for the first time in years, S&P 500 revenues are estimated to swing sequentially positive with a year-over-year 7% rise in the current quarter followed by nearly 9% and 7.7% in the first and second quarters of 2010, respectively. For this reason, it is likely that 2010, like 2009, will be a year of rising earnings estimate revisions.
The second reason is the immense investment promise of globalization. In Gregg Easterbrook’s new book Sonic Boom, he describes the coming age of global integration as “one that will produce riches that none of us can imagine and scatter them more widely than ever before.” It took multiple generations to build a western major metropolis, Shenzhen, China, with a population of 9 million, which did not exist a generation ago. Global promise has rejuvenated old industrial towns like Erie, Pennsylvania, where General Electric’s world class locomotive plant is an important profit center while delivering 40% of the locomotives it makes to China. Easterbrook cites the American Academy of Sciences’ estimate that “85% of economic growth is now produced by new ideas.” Also in 2007, new companies funded by venture capital provided 10.7 million American jobs and generated $2.3 trillion in revenues—a sum equal to the GDP of France. As for the economic crisis that just befell us, Mr. Easterbrook reminds readers that “capitalism is the only economic system in history that is rendered stronger by its own instability.”
The third reason is contrarian; stocks are still an unpopular asset class. In addition to over $3 trillion in money market funds, billions have flowed into bond funds. Should interest rates break their 20-year trend line decline and begin to rise, fund holders may well search for alternatives in the dividend-rich stock market. My personal S&P 500 prediction target for December 31, 2010, is 1300, representing a 16.5% gain from the close in 2009.
Happy New Decade!