A return to normalcy could mark 2010

December 14, 2009
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Editor’s note: This is the second part of a two-part look at financial markets in 2010.

With 2010 just weeks away, the Business Journal asked Mitch Stapley to peer into his crystal ball and talk about a variety of financial matters for the coming year. Here is the second installment of that conversation with Stapley, the chief fixed income officer for Fifth Third Asset Management.

Business Journal: Where will the U.S. dollar stack up on the international monetary standard in 2010? Will the euro replace the dollar?

Mitch Stapley: There are real issues with that, using a currency based on a group of nations. That’s just realistically not going to work, economically, over time, and I don’t think they’ve got the financial wherewithal to support that.

The dollar will remain the reserve currency. But we’re due for a period of weakness here in the dollar due to our relatively low level of interest rates. I think you’ll see the dollar, which is down almost 8 percent on the year, maybe have some additional weakness early into 2010.

But when the Fed begins the process of raising rates and when the market begins to anticipate that the Fed is going to begin raising interest rates, they’ll be beating the drum pretty loudly. When they start to do that, then you’re going to see the dollar begin to rally on the anticipation of there being higher interest rates. So that will be the moment when we’ll see the dollar strengthening.

And, at that time, I think it will be real interesting to see what will commodity prices do, what will emerging market stocks do, and what will stock markets globally do? There have been a lot of rallies here that have been fueled by a weaker dollar. What happens when the dollar begins to strengthen?

BJ: With the nation’s economy so dependent on consumer spending, what do you think consumers will do next year?

MS: So we’ve got a consumer that borrowed too much, saved too little, spent too much — and that’s over 70 percent of the economy. So now we’ve got 70 percent of the economy that needs to take the savings rate from essentially zero a few years ago up to around 7 or 8 percent. They’ve bumped that savings rate to about 4.5 percent, and that number is going to go higher. The faster it gets there, the quicker the consumer begins to spend and that 70 percent of the economy begins to go.

But that’s not going to happen overnight. That’s a process. The quicker we get through it, the better. But the fact is, we still have to get through it because savings still has to go up. We’re seeing consumer indebtedness go down. Consumers are clearly paying down debt. They’re not only saving more, they’re paying down debt.

With consumer debt falling, you’re seeing financial houses being put in order. There is just nothing that we can really do to turn that process around quickly. It’s not something that is going to happen in a month or two, or a quarter or two. With every dollar the consumer ends up putting in the bank toward paying down debt, toward living more within their means and not on easy credit, the more solid and fundamentally sound their personal balance sheets are going to be. So the next time the economy does turn down, the less severe the shock will be to the system.

While consumers have been shocked by this, banks have been shocked financially. The days where consumers would get a credit card in the mail with a $10,000 credit limit on it are gone. Banks are going to be more sober in terms of their lending. Consumers are going to be more sober in terms of their borrowing. And that is fundamentally good news for the ability of the economy to handle another downturn at some point in the future.

In the immediate term, that means 70 percent of the economy is going to be spending less than they did, say, over the last 10 years. And that means a lower grade of growth. No way around it.

BJ: What do you see for the fixed-income market next year?

MS: Some of the big news stories out there are 2010 might actually be a little better year for savers, especially later in the year when they look at how miserly their returns are in, say, short-term CDs and that. When the Fed begins to raise rates, it will undoubtedly be a friend of the saver again.

We see markets like the high-yield market, which has had such a monster rally this year, as being an area where, if you’ve been involved, you need to take some profits. Definitely don’t chase the performance of that one because that market is probably due for a correction. The fundamentals in high yields are pretty stark. Defaults are up year-over-year, certainly at 10-year highs, and recoveries are down. That is not a good fundamental combination for high yields.

With defaults up and recoveries down, for the market to rally like it did is a really good indication it’s not trading purely on the fundamentals, and that notion of it is juice to the system. As that juice begins to get pulled out, high yields could have a pretty good sell-off next year.

Overall, we think rates will probably be pretty stable, outside of the high-yield market, for the first three quarters of the year. But, again, when the Fed begins … raising interest rates out there,’ that’s when the markets are going to be under some pressure.

BJ: It’s a year from now. How was 2010?

MS: I think what we’ll see in 2010 is hopefully a return to normalcy, and I mean more normalized asset returns. We don’t expect the stock market to be returning anywhere near 25 or 30 percent. A 5 to 7 percent type of return is probably realistic in the stock market. The economy growing from 2 to 2.5 percent. As for the unemployment rate, I think we’re seeing it right about its peak here. It could be slow going next year to really see the unemployment rate go down.

But if we’re talking at this time next year, you’ll look back and say this was the year that lacked a lot of drama and a lot of the volatility and the surprises. This was the year of more sustained recovery in both the economy and the stock market. I’d count that as a pretty good year.

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