So what’s in store for 2010?

Well, I have to admit, 2009 was a much better year for markets than I had anticipated. Most market sectors finished in positive territory (the two notable exceptions being Japanese equities and UK gilts) and for the brave, there were large gains to be made from global emerging markets (50% +) and Technology funds (40% +), while those who bought individual shares in sectors such as banking and house builders at the bottom and sold at the peak could have multiplied their investment by fivefold.

What was responsible for this extraordinary turnaround? From the ashes of Lehmans and Northern Rock came the new dawn of hope in the form of Quantitative Easing (“QE”) – central banks threw billions of pounds, dollars and Euros at their respective banks in order to keep liquidity in the markets and keep struggling companies afloat, and many now hope for shares to continue rallying in 2010 to complete a “V” shaped recovery.

However, I very much doubt that things will be that simple. Some market anomalies exist and headwinds will undoubtedly strike at some point; most likely when we least expect them!

One of the main anomalies is the ongoing debate between “inflationists” and “deflationists”. While those in the deflation camp appear to have won the argument to date, many of the investments which did well in 2009 would normally be associated with rising inflation – to whit: gold, commodities and property shares. At the same time, gilts, which should be a prime beneficiary of deflation, struggled. The timing and nature of QE exit strategy will, therefore, be a key determinant of how markets perform over the next 12 months. Personally, I don’t expect inflation to be a problem during 2010, but it could present a large problem in 2011.

The UK has been one of the few economies not to have  exited officially from recession and this must be a worry going forward. If unemployment remains high and consumers continue to save rather than spend, the government tax take will be lower than expected and it will be unable to finance its debt. Given the probability of this happening, the recovery enjoyed by the UK stock market may well be short-lived. I expect the FTSE to continue higher in the short term but then to pull back sharply as reality hits home and interest rates rise towards the end of the year. My year-end target at present would be around 5,000, based on a weaker recovery than many anticipate..

The US remains dogged by unemployment and markets will struggle to make much more headway until unemployment and housing starts both show some sustainable recovery. That said, the Americans were the first into the recovery programme, having cut interest rates well before the UK and I would expect them to lead the way out. A rally in the 4th quarter of this year could see the Dow Jones sustaining a level of about 11,000, around 3% above today’s levels. However, this would be greater in sterling terms if my currency forecasts prove correct (see currencies section).

Japan has rallied from its lows but still sits a staggering 70% below the all-time high on the Nikkei Dow of over 38,000 (currently 10,700). However, on a valuation basis Japanese shares are some of the cheapest on offer, with price to book ratios of under 1 almost commonplace. A bet for the brave would be to overweight Japan this year; I would not rule out a year end level for the Nikkei of 13,000.

Europe potentially has the biggest concerns entering 2010. While the large economies of Germany and France should continue to tick along, the peripheral countries of Greece, Spain and Ireland may struggle and more than one commentator has suggested that one or more of these nations may be forced out of the Euro. This may remain an extreme view for now but the risk of large amounts of capital being used to save the Euro zone cannot be ignored. The knock-on effects could be substantial and can see the region losing investors' money, both on an absolute basis and more predictably, on a sterling adjusted one.

The outlook for Asia Pacific (ex Japan) looks to be finely balanced. The region performed exceptionally well in 2009, but markets now seem to be factoring in a global recovery and any deviation from this event could see a severe pull-back in the region. While internal trade and especially increased trade with China should make this area more immune from a global setback than previously, there is still scope for a large fall should investors become nervous.

Emerging Markets may once again offer above average returns. One of our favoured areas remains Russia where, after the market was savaged in 2008, it more than doubled in 2009. However, at a current level of just above 1,500, the RTS is the same level as mid 2006, and still 40% off its peak. Russia is home to many rapidly expanding companies, not all of which are oil related and a further 25% rise from current levels looks to me to be entirely reasonable, although investors should be aware of the considerable political risk attached. China should continue to deliver strong GDP numbers, although its currency movement against the US dollar will probably be a bigger determinant of how much investors make from the region and strong GDP growth is already being factored in to share prices, so the smallest under achievement could result in a market sell-off if falls in confidence levels escalate. Given my nervousness about global growth prospects, I would expect a small fall in China in 2010 but a small gain from the currency, resulting in little overall movement for the sterling investor.

Fixed Interest

Having made some good returns in 2009, investors will need to be quick-footed to do the same again in 2010. While interest rates should stay low for the first half of the year, the apple cart may be upset if QE starts to be reversed, or, particularly in the UK and Euro zone, government debt downgrades are made. The outlook for UK gilts is particularly finely balanced, as a prolonged period of QE coupled with demand from banks and pension funds could see further appreciation in gilts but any inflationary threat would clearly be bearish. Investors may do best to steer the middle ground, buying corporate bonds yielding 2% above government bonds, and keeping a careful eye on economic data.

Property

Commercial Property has shown signs of recovery in 2009 and there are some good yields on offer. However, a double dip recession would almost certainly result in a further decline in prices, and with the exception of one particular cash rich Property fund, we do not expect to benefit from the sector in 2010.  However, overseas property may deliver positive returns to UK investors..

Commodities and Currencies

2009 was the year of commodities, and commodity-related currencies, with shows of strength from gold, oil, copper, the Canadian Dollar and the Aussie Dollar. While I expect this long-term trend to hold, short term movements are likely to be volatile as investors come to terms with which way the economy and most notably inflation, is heading. In any event, we expect the US dollar and gold to be well supported as both are seen as safe havens and are easily tradable. Our current forecast for gold is around $1,400 per oz. compared with the current level of $1,150. However, this could be enhanced by a £/US$ move from 1.60 to 1.40 and possibly lower, depending on how well (or otherwise) whichever government is in power, deals with the UK’s substantial debt.

Please remember that the value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.

Past performance is not a guide to future returns.

Where RHG has expressed views and opinions, these may change.

Current tax levels and reliefs may change. Depending on individual circumstances, this may affect investment returns.