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Was it 10 for '10 or 5 for '10?

01/31/2010

New decade, new beginning, a global economic recovery reflected in rising capital market prices. That sentiment flourished throughout the end of 2009 as multiple market experts pontificated about the prospects for 2010. I believe 10 for '10 was the common theme for Investment firm research reports.  I myself, on this very blog, foreshadowed the prospects for 2010 with great optimism for the beginning and end of the year, with a baseball season of frustration in between. So, here we are, one month into the year and, quite candidly, I have to admit very few, including yours truly, expected this.

For horse racing fans, which I am not, the start of 2010 is similar to the 2006 racing season. After the Kentucky Derby, the expectations were rather high heading into the Preakness for that wonderful horse named Barbaro. But, a "false-start" ended his Triple Crown hopes. Barbaro was euthanized seven months later. I would imagine the political careers of the Incumbents in D.C. will meet a similar fate in November if the anti-capitalism rhetoric remains.

Let's strategize about where we are now and what investors should do. Friday evening, I received multiple congratulatory emails, text messages, and even a few phone calls from friends "on the street" who applauded my Fast Money performance that evening. It didn't make me feel any better, by the way. I entered the NASDAQ in a rather surly mood but was able, in a gracious, respectful manner, to take the other side of the gloating bears who predict that the highs for 2010 are already in place. I defended all of us who are frustrated with the actions of Washington and are allocating capital into the market.

As we begin to prepare for Armageddon 2, the sequel, please remember that most movies sequels are a flop.  I expect "Armageddon 2" to be just that - a flop.  I am not buying tickets to see it; I am not playing the market from the short side, or going all into cash, or Treasuries. It feels lousy right now.  At the end of 2009 I mentioned a "baseball season of frustration," but I didn't expect Washington to initiate a "year of frustration."

The near term selling pressure may continue but I encourage investors not to be tempted and to stick to their investment plan. On any further capital market weakness, I would be rather excited about the opportunities for corporate bonds. Natural resource and commodity prices historically experience their weakest pricing in the first quarter of the year, so here we are and we foreshadowed that weakness at the end of 2009.

Let's sum it up - bottom line - what are the differences between Armageddon 1 and Armageddon 2, the sequel coming soon to a theatre near you:

  1. Earnings - this earnings season has been excellent. Strong top line sales have finally reemerged. Over 50% of those companies reporting have beaten top line consensus estimates, versus the 40% historical average. Less than 10% of those companies reporting have missed top line estimates, versus the 15% historical average. The Oscar winning Armageddon 1 had a rather different earnings storyline.
  2. Credit Spreads - in Armageddon 1, the suspense was in attempting to determine how wide the credit spreads could actually get. Currently, credit spreads, and default rates are declining.
  3. Sovereign Risk - in Armageddon 1, the United States, capitalism, and the global financial system itself were on the brink; this time the risk is more regionalized. I am certain that this will come across somewhat callous, but if the capital markets survived the global risk last year, we can work through the problems of Greece.
  4. Global Economic Data - in Armageddon 1, GDP and ISM were contracting; currently, we are expanding.
  5. Politics - currently cast in the leading role for Armageddon 2.  History shows it is a role in which it fails - politics and populism reign supreme. However, the rhetoric that comes out of D.C. seems to change rather quickly - think about the reversal on the KSM New York City trial. Incumbents will realize that higher capital markets are their best friends heading into the November elections. If we drop even further, President Obama might even encourage buying stocks again.

 I never suggested that the capital markets would experience 2009-like returns in 2010. However, there are 5 of 10 that suggest the much recently hyped sequel, Armageddon 2, will be a flop.

Virtus Investment Partners provides this communication as a matter of general information. The opinions stated herein are those of the author and not necessarily the opinions of Virtus, its affiliates or its subadvisers. Portfolio managers at Virtus make investment decisions in accordance with specific client guidelines and restrictions. As a result, client accounts may differ in strategy and composition from the information presented herein. Any facts and statistics quoted are from sources believed to be reliable, but they may be incomplete or condensed and we do not guarantee their accuracy. This communication is not an offer or solicitation to purchase or sell any security, and it is not a research report. Individuals should consult with a qualified financial professional before making any investment decisions.