Stock market 2010: Analysts predict a fast start, then bumps

Many investment analysts are optimistic that the stock market will keep rising in the first part of 2010. But come June, they see challenges, and by year-end, some serious stock-selling.

Behind that forecast: The market is ending 2009 with some momentum. Since the lows in March, the major averages have gone up about 60 percent. For the year, the Standard & Poor’s 500 is up more than 20 percent.

“Besides the momentum, I think we will have another round of positive earnings surprises. So stock analysts will be adjusting their earnings estimates upwards, and money will continue to move away from the dollar and into other assets such as the stock market,” says Fred Dickson, chief market strategist at D.A. Davidson in Lake Oswego, Ore.

In fact, earnings will still outstrip estimates next year, as they did for much of 2009, some market-watchers say. One of those is Ed Butowsky, managing partner at Chapwood Capital Investment Management in the Dallas area. He anticipates that corporations will crank up their exports, thanks to a lower-valued dollar, and that Wall Street will race to buy stocks in these companies. “Next year, the market will be 26 percent higher than today,” he says. His only caveat: Interest rates can’t go up.

Yet some think that the market’s positive direction will be tested by the spring, when they expect the Federal Reserve to set the stage for higher interest rates. At the moment, the Fed is telling investors that interest rates will remain low for an “extended period.”

“When they remove that phrase [extended period], that signals to the market that rate hikes are coming,” says Jeffrey Kleintop, chief market strategist at LPL Financial in Boston.

Mr. Kleintop expects other central banks around the world to join in interest-rate hikes. Although that might help address a potential inflation problem, the stock market could begin to give back some of its gains, especially in the second half of the year, he says.

Also, by midyear, investors may start to hear some rumblings from Congress about letting the Bush tax cuts (for capital gains, dividends, and other earnings) expire at the end of 2010. “Topic 1 [for market-watchers] will be massive tax reform that investors will translate into massive tax increases,” Mr. Dickson says.

But the prospect of higher tax rates might not mean that the market will end 2010 with losses. Stock valuations still seem reasonable, says Dickson. “We don’t feel close to a peak in the cycle,” he says.

But Kleintop can envision being more cautious. He expects to cut his equity (stock) holdings from 70 percent to 65 percent, or maybe even to 60 percent, if he begins to feel the need to be defensive. “We may not flee stocks, but we may just turn neutral,” he says.

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