2010 Investment Outlook

New Years Resolution: Saving!
Last Year
Transition
Developing Market Correction
Bond Funds vs. Stock Funds
Bond Outlook
Dollar Outlook
Gold and Energy
S&P500 Index?
Indexes vs. Active Management
Themes

New Years Resolution: Saving!
It is the start of the New Year and now is the time to make those New Years resolutions. Do you know your retirement savings rate? Our goal on the MaxOut Savings Show is to have everyone saving a minimum of 10% of their income plus the company match. If you are behind in your savings plan or have lost money in the Debt Crisis, then your savings rate should be over 10%; move that rate to 15% if you can. Now is the time to start the New Year out right by increasing your savings in your retirement plan. Speak to your HR person about boosting your savings rate higher. Remember the motto of the MaxOut Savings Show, “Save Aggressively and Invest Conservatively”.

Last Year
For the last four years when we have issued our MaxOut Savings Report Yearly Outlook, we have been fairly fortunate to get a good read on the investment outlook for the New Year. The 2008 MaxOut Savings Outlook was one of the best of any investment letters out there in predicting the Debt Bubble crisis.   For 2009 we caught a number of major trends, although it is kind of hard to tell how well we really did since everything went up. We do not believe that will be the case for this year; many investment classes are expensive across the board. So far in 2010 it has been very hard to find many good ideas that are not overbought, often a signal for caution!   That will change soon enough as the New Year gets underway. Overall, 2010 will be a year of transition and the year of the stock picker.

Transition
The outlook for investments in 2010 will be shaped by how the United States and the world handle the transition from massive deficit spending and the lowest interest rates in several generations to reduced government spending and higher interest rates. The United States Treasury borrowings are expected to remain high at $1.5 – 2.0 trillion in fiscal 2010, which began in October of 2009. The problem now is as the economy stabilizes, interest rates will have to move higher as the long expected tightening cycle begins. How this cycle plays out will greatly affect how the financial markets—both stocks and bonds—perform during the year.

A little known fact is that in fiscal 2009 a very large part of the $1.5 trillion federal deficit was funded by the Federal Reserve. Contrary to popular belief, China funded only around $100 billion of the federal borrowing according to Bianco Research LLC. According to Bianco, foreigners were recently purchasing about 16% of the US treasury issuance, down from the 90-100% range over the last five years. That compares with a United States trade deficit with China that should be over $220 billion in 2009. The reality is that the world has already materially slowed down the buying of US government debt.

We believe two events will drive interest rates higher for bonds in 2010. First, as the economy begins to grow again, the Fed will be forced to tighten, given Fed Funds are at record lows of 0.25%, to a more normalized rate for moderate economic growth. The second factor will be the dollar. As investors around the world lose confidence in the Obama Administration and Congress to reign in government spending and run away deficits, they will sell the dollar off. To support the dollar, the Federal Reserve could be forced to raise interest rates sooner than they would prefer to do. In the second scenario, the “dollar vigilantes” force rates higher. One of the reasons we have favored this scenario is our thinking that the Federal Reserve will try to keep rates under .5% for the next 12-18 months unless something forces their hand.

Equity Markets
When the tightening of interest rates begins it will affect investments in all asset classes. We must keep in mind that much of the rally in the stock markets worldwide has been fueled by the easy money and very low interest rates provided by Central Banks around the world. In essence, the worldwide stock and bond markets have risen on a sea of liquidity and government spending. This liquidity is now at the beginning of the process of being withdrawn while government spending is also being reduced. As that money is withdrawn, it will slow the stock market’s progress and should lead to a substantial correction in the stock market. For 2010, we expect the stock market to become more volatile and choppy than the last nine months. We expect to see a substantial correction in the stock market in the first half of the year. We would use these corrections as buying opportunities.

As investors prepare for higher interest rates, income stocks such as preferred stocks, REITs and MLPs will decline because they are viewed as income vehicles. We would be very cautious of these investments as they have had a run up as investors scrambled for more yield.

We continue to favor the large cap multinational companies with good balance sheets and dividends. With the dividends you can collect 3-6% per year while you wait for the stocks to move higher over the long term. In many cases these stocks are paying dividend yields higher than 5 year bonds! These companies are poised over the long term to profit as the world wide middle class continues to grow. They also offer protection from a declining dollar with overseas exposure. In addition on a global valuation basis, they offer some of the best value anywhere in the world.

Developing Market Correction
During 2009, almost $80 billion was invested in developing markets after a withdrawal of $50 billion in 2008.   This has resulted in substantial returns for many developing markets particularly in dollar terms. The Dow Jones Global Indexes have seen huge moves. The DJ Brazil index has risen 127%, Russia 105%, India 98% and the Shanghai Composite Index 80%. The moves have been precipitated by huge mutual fund inflows as investors have moved to diversify out of the United States. The developing markets have been viewed favorably by investors for a number of other reasons: higher growth rates, lower debt levels, positive current account deficits, a growing middle class and generally investor friendly economies. The total return in the equity and bond markets has been increased further by a declining dollar against almost all major currencies. The combination of quality companies, huge mutual fund inflows and a declining dollar has resulted in these outsized returns in developing markets for 2009.

We would be cautious in 2010 in the developing markets and believe we will see a substantial correction sometime in the early to first half of the year. The developing markets are now trading at over 20x earnings, a high historic PE ratio for these markets. For now the dollar has stabilized and could go up over the near term. This could cause investors to sell their developing markets positions. When investors start to sell these markets, they often find that the stocks are hard to get out of without driving the prices substantially lower. We believe a large number of investors will try to sell at the same time, resulting in a steep correction due to liquidity issues in these markets.   The decline could be made worse if the dollar stabilizes, as it now has, and moves up over the short term. This will result in equity losses as well a currency loss; a double whammy. Because of a falling Yen will help Japan’s export driven economy and a new government that will make tough changes in Japan. We expect Japan to be one of the better performing stock markets for 2010.

Bond Funds vs. Stock Funds
Investors scrambled in 2009 to reduce the risk in their portfolios from the volatile stock market by increasing the weighting of bond mutual funds. Investors purchased over $250 billion in bond mutual funds in 2009. This compares with around $10 billion invested in US equity funds. Much of this money was invested at record low interest rates. We will now have to see how those bond funds perform over the next couple of years as we begin a new rate hike cycle as the Federal Reserve tightens and raises interest rates as the economy recovers at a very slow pace over the next couple of years.

Bond Outlook
Regarding fixed income, after pouring in over $250 billion into domestic bond funds, bonds are at record low yields and subject to a decline. We believe that the junk or high yield sector is overvalued and subject to a substantial correction. They will decline in price if interest rates start to rise if the economy improves and the Fed raises rates. On the other hand, if the economy begins a double dip they will decline because of bad fundamentals and risk aversion.

We would take a look at good quality corporate bonds with maturities of 5 years or less if possible to protect from inflation and higher interest rates. On a pull back, convertible bonds offer an opportunity because they allow for income as well as growth from a rise in the price of the stock. Over time, convertible bonds will offer a level of inflation protection if bought at a good value.

During 2009, the Federal Reserve has been the major buyer of home mortgage loans to keep mortgage rates low to support the housing market. The Fed has pledged to start reducing its purchases by the end of the first quarter of this year. To stabilize the markets during the transition, the Treasury is allowing Fannie Mae and Freddie Mac to increase the purchases of mortgages and the government will guarantee them (I know, another bailout!). Even with this help we would be a seller of mortgages and mortgage bond funds, except in special cases. The sale of mortgages is because the mortgage bonds have an artificially high bid from the Federal Reserve and we expect inflation and high interest rates. None of this is good for people holding 30 year, low rate mortgages.

Dollar Outlook
We believe after a short rally the US dollar will continue to decline. We expect we will see other crises in some currencies around the world. During 2010, we will see additional crises in some Eastern European countries, former soviet bloc countries (particularly Ukraine) and Arab countries. We will see further attempts in these crises to paper over the problems with loans and help as we have seen in Dubai. The problem is that these “rescue” operations are doing little to get to the root of the problem and that is excess debt in the economy. Therefore, for 2010, all foreign debt will not go up at the same rate. The markets will now start to differentiate the winners from the losers.

We think the Chinese Yuan is best positioned to rise against the dollar. We have avoided the British pound for several years because of the size of their financial sector in relationship to the economy; it should continue to be weak. To that list we would become cautious of the Japanese Yen because of Japan’s massive debt to GDP ratio that is approaching 200% as compared to the United States ratio of about 90% of GDP. As an aside, a decline in the Yen could help the Japanese stock market.   Overall, we continue to like the foreign bond markets.

Gold & Energy
As the world continues to try to contain the effects of the Debt Bubble, they will err on the side of inflation. Therefore, we continue to like gold and silver, both of which are in a long term bull markets. Our target for gold this year to 18 months is $1500 for gold and our target for silver is $25. Precious metal stocks should continue to do well in 2010.   Energy inventories and prices of oil and gas remain remarkably high given the low level of economic activity. Oil and gas stocks should have a correction sometime in the first quarter that will present a better buying opportunity. We look for oil to trade in a range of $60-90 currently it is trading at $83.04. Natural gas prices should remain moderate due to the large amounts of shale gas now being drilled in the United States. We continue to like the energy stocks with an emphasis on companies with low debt and good dividends.

S&P 500
The year 2009 has ended as one of the worse decades for stock market performance in the last 100 years as can be seen from the chart below. For the S&P 500, if an investor put $10,000 in the S&P 500 on Dec 31, 1999 he would have $9,090 on Dec 31, 2009, a loss after 10 years of investing. Over the last decade, investors have lost money investing in the S&P 500 index fund. During that time the many investment managers that made money, were more cautious and better investors.

Indexes vs. Active Management
This brings us to the importance of active investing to grow your assets in retirement over passive investing in indexes. It demonstrates the need to actively manage risk in your retirement portfolio with a combination of stocks, bonds and cash. By actively managing the risk, we can stay out of internet stocks and financials as well as other bubbles that can destroy a retirement portfolio. The above chart brings out the need for high quality research and stock picking to build long term wealth. For the record, we believe the next decade will have much better performance for stocks than the last one.

Themes for 2010
US Multinational Equities
Telephone Utilities
Energy Stocks (on pullback)
Healthcare
Cash for Correction
Short-Term Bonds
Gold/ Silver
Foreign Bonds
Short 10 Year Treasury note
Chinese Yuan
Japan

Sectors to Under-Weight
US 30 year mortgage debt
US Government Bonds (over 3 years)
High Yield Bonds
Preferred Stocks
REITs
MLPs
Developing Market Equities
Japanese Yen
British Pound
Poor Quality Municipal Debt

I would like to take this opportunity to wish all of you and your family a Happy and Prosperous New Year!

Do you have an account at Fidelity?
Do you already have an account at Fidelity Investments? Why not let the MaxOut Savings Advisors Team actively manage the assets for you at Fidelity? We will make the investment decisions and you can sit back and relax. We use the same value based investment strategies we talk about on the MaxOut Savings Show. In most cases you can sign a simple form and we can use your same Fidelity account to get you started.

Considering an IRA Rollover?
If you are retiring soon or considering an IRA rollover, let the MaxOut Savings Advisors Team handle your IRA rollover. We can help you take advantage of the NUA tax break if you have low cost basis stock in your company plan. We will sit down with you and go over your financial situation and needs and come up with a plan. We will show you how we manage accounts using our value analysis strategy to grow your investments and reduce risk.

MaxOut Savings Advisors: Actively Managing Risk
In these volatile times, investing your retirement funds can be difficult and time consuming. Is your advisor looking at risk and actively managing your retirement? Hiring the MaxOut Savings Advisors team to manage your money or IRA rollover is a great first step toward a successful retirement. MaxOut Savings Advisors, LLC is an SEC registered, fee-only investment advisor based in Houston, Texas. Ted Geoca has over twenty year’s of investment experience managing clients’ retirement assets. We invest in stocks, bonds and mutual funds for our clients using a value analysis strategy that we have developed over the last twenty years. We look at risk as well as return to actively manage your investments through today’s changing markets. We use Fidelity Investments as the custodian for our clients’ assets. If you would like MaxOut Savings Advisors to manage your retirement investments using our value methodology, I would be happy to meet with you. To schedule an appointment please give us a call at 713-627-0400 or email me at ted@maxoutsavings.com.