Rising 2009 market could haunt investors in '10

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BOSTON - If the key to successful investing is buying low, then an abundance of caution is in order if you're rebalancing your portfolio.

This year's rally has sent prices for everything from stocks to bonds to gold so high that easy pickings are unusually hard to find heading into 2010.

"There isn't that much to be excited about," says Ben Inker, asset allocation director at GMO, a Boston-based manager of $102 billion for institutional clients such as endowments, foundations and pension funds.

If pros like Inker admit difficulty finding decent investments, it's especially hard for average investors looking to adjust their mix of stocks, bonds and other assets at year-end. After all, many mistakenly buy when a rally has nearly run its course, or sell in panic near the bottom.

Sure, the market feels safer than it did when almost everything was crashing — to prices so low it seemed there was nowhere to go but up if you were patient.

Those with the fortitude to take money off the sidelines last winter or spring have been richly rewarded. The Standard & Poor's 500 is up more than 60 percent since bottoming out March 9. A broad measure of the bond market, the Barclays Capital U.S. Aggregate Bond Index, is up more than 7 percent since then. Riskier high-yield bonds, meanwhile, have surged more than 60 percent.

Government policy that's made it easier to borrow has helped fuel some of the gains for more speculative investments, from junk bonds to racy emerging markets stocks. That policy won't be ending anytime soon — Federal Reserve Chairman Ben Bernanke pledged Monday to maintain interest rates at near zero for an "extended period" to boost spending.

"It's going to be tougher in 2010, because we've had this big flow into risky assets," Inker says. "They were all cheap last winter, but they've all gone up 60 percent-plus."

Even after those gains, nearly everyone agrees the economic recovery is still shaky. So strategists like Inker are having a harder time figuring out where to put money to work.

"It's a little bit frustrating, because the temptation is to say, 'Well, stocks have had a great run, so let's take some money and put it back into fixed income,'" Inker says. "But then you look at the risks in bonds, you say, 'It's not clear what we really want to own.'"

Inker and another asset allocation expert, Rob Arnott, both worry about long-term inflation eroding bond returns. And Arnott — chairman of Newport Beach, Calif.-based Research Affiliates, and manager of the $14 billion Pimco All Asset Fund — doesn't like much in the stock market, either. He contends it's "expensive, and priced as if the recession is over."

In such times, many investors seek refuge in gold. Its appeal is now brightened by the weak dollar, inflation risks, and general fears about the economy and government debt. But after gold's more than 40 percent rise this year to around $1,200 an ounce, Inker suspects the price is too rich.

The more conventional options:

STOCKS — It wouldn't be a stretch for prices to modestly climb well into 2010. That's because it's not unusual to see recoveries from extreme bear markets last more than a year. Standard & Poor's says the S&P 500 appears poised to rise 9 percent by next July, if past patterns coming out of bear markets play out again.

But Inker and Arnott suggest more gains may not be sustainable, since this economic recovery is relying on government stimulus and rock-bottom interest rates that can't last forever.

Rising stock prices hinge on Wall Street forecasts for a sharp rebound in corporate profits next year.

Inker says he's nervous about analysts' projections that profit margins will return to mid-2007 levels by the end of 2011: "They're saying that by two years from now, things will be as good as the best time ever to have been a U.S. corporation. That doesn't seem plausible," Inker says. "The economy is trying to work through too many problems now to believe things are going to be that good."

That skepticism is why his firm's current stock picks are mostly defensive. Those include blue chips Coca-Cola, Johnson & Johnson, and Microsoft — established companies with little debt and plenty of size.

Those companies "have less to worry about if the recovery sputters out," Inker says, and offer a good chance of decent returns.

BONDS — Those shifting into fixed income investments face headwinds. The biggest is a growing federal deficit that could lead investors — especially big foreign buyers like China — to demand higher premiums to offset the greater risks from buying government bonds. That could lead to interest rate increases, eventually reawakening long-term bonds' biggest enemy, inflation, which erodes their potential return.

That's why Inker's current favorites are Treasury Inflation-Protected Securities, or TIPS, a common hedge against rising prices.

The only U.S. fixed-income investments Arnott likes now are short-term Treasury bonds. He favors Treasuries with maturities of a few months to just a couple of years, expecting inflation won't rise much above its current near-zero level anytime soon. But Arnott projects inflation will return to a more typical 3 percent by 2011.

"I think this is a wonderful time to hunker down," Arnott says, "and take a very conservative investment posture."


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