2010's Investing Pitfalls

Apparently, the 63% rally from March ’09 lows wasn’t good enough…

Wall Street analysts have once again set high the bar high for 2010. Sentiment at big firms is 100% bullish.

Take a look at these 2010 targets from Wall Street powerhouses:

Rose-Tinted

Fundamentally, those targets are generous… to say the least.

The most bearish firm, Morgan Stanley, sees 9% more upside this year. To get a better idea of how lofty these targets are: At 1200, the S&P 500 would be trading at 23x estimated 2010 earnings. At 1350, it would sport a bubbly 26x P/E.

But don’t let that scare you off by itself — fundamentals rarely stand in the way of a good ol’ rally — rational or not. So even though the market is trading way above its historical norm of 15x earnings (and yielding less), it can always go higher.

That’s especially true since Ben Bernanke and his loose money policies were just confirmed for a second term. When Bernanke rains money down on Wall Street, it’s a matter of how it will be gambled, not if.

After this article runs, it’s inevitable that someone will remind me about the forward-looking nature of markets. Toward the end of recessions, stocks often do look expensive. But as soon as spending picks up, earnings will rise to meet expectations.

In many cases, that’s true — take 1987, for example. But in this case, analysts are making a dangerous assumption — that we’re in the clear… and already on the path to self-sustaining growth.

That may be the case, but there are lots of potential pitfalls. Today I want to tell you about two of the most pressing ones.

Pitfall #1 – Housing

This is the big one. The Feds are currently engaged in a Herculean effort to prop up America’s housing market. It involves the Federal Reserve, FHA, Fannie Mae, Freddie Mac, and even the FDIC.

The first test for housing comes this month as the Fed winds up its program to buy mortgage-backed securities (MBS). The program is 93% complete, with $1.16 trillion already bought. The Fed is counting on private demand to take over after the program expires.

I’m skeptical. Once the government starts a program like this, it’s very hard to stop it. As Milton Friedman said, "there’s nothing so permanent as a temporary government program."

Of course, the Fed has opened the door for the possibility of more purchases, if private investors don’t pick up the slack. It’s unclear how investors would take news of the Fed further expanding its balance sheet, but it’s sure to ruffle a few feathers — especially with foreign holders of U.S. bonds.

There’s also the lurking Option ARM resets, a topic Wealth Daily‘s Ian Cooper covered in a recent write-up.

Pitfall #2 – Geithner and Summers

Tim Geithner and Larry Summers, Obama’s short-sighted and bank-friendly duo, seem to be losing favor with both Congress and the public. It’s about time. These guys are an economic disaster.

But if either of them gets canned, the market could react violently. It would be a good thing in the long term, but could cause some nasty short-term volatility. One thing markets don’t like is uncertainty. And they know how these guys operate (probably too well).

Conclusion

Markets are fundamentally overvalued. There are a ton of catalysts that could set off the next crash. The two listed above are just what I perceive to be the most immediate threats.

Another round of Fed easing seems inevitable, and it could start as early as March 1.

If this does play out, it should set off the next leg-up for commodities… and signal the end of the dollar bounce. In fact, one such opportunity in commodities is already panning out for our readers. It’s based on "inside" information put together by one of my colleagues, who tells me this information may not be available to individual investors much longer. For now, you can read the full report right here. 

Until next time,

Adam Sharp
Analyst, Wealth Daily