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Outlook for 2010: S&P 500 Earnings to Rise 35%?
By Louis Navellier

After a scary start, 2009 turned into a great year. From the intra-day lows of Friday, March 6, the Dow is up 62%, the S&P 500 is up 67% and NASDAQ is 79% higher. Most foreign markets did even better, but even an all-American portfolio looks a lot healthier than it did 10 months ago. I still believe we're in for an "avalanche of good news" through at least next May (i.e., first-quarter earnings reporting season), due to strong year-over-year comparisons. Predictions for Q1 S&P earnings to be 63.5% above the first quarter of 2009 seem reasonable, as do predictions for the remaining three quarters of 2010 at +33.2%, +24.9% and +27.2%.

A Falling Dollar and Rising Commodity Prices

Overall, 2010 will be characterized by rising long-term interest rates as inflationary forces grow, due to the global economic recovery and a weak U.S. dollar driving commodity prices higher. Already, in the year past, crude oil prices posted their largest annual gain in nearly a decade, more than doubling to almost $80 per barrel, despite higher-than-normal inventories. Gold gained 28% to close near $1,100 per ounce, while silver and platinum each gained over 60% last year. Copper, steel, most crops and other key commodities should keep rising in 2010, which will put upward pressure on inflation and interest rates.

Speaking at the American Economic Association conference over the last weekend, Federal Reserve Chairman Ben Bernanke said he's "not ruling out higher interest rates" to stop dangerous "bubbles" from forming. At the same conference, Fed Vice Chairman Donald Kohn said that the Fed will need to be ahead of the curve in withdrawing stimulus in a gradually improving economy, although he warned that the nature of the economic crisis means there is no clear "road map" for the action they'll need to take.

Despite the U.S. dollar's recent strength - based on improving economic news and concerns that Greece might default on its sovereign debt - the U.S. still has the third-highest budget deficit (as a percent of GDP) in the world, after only Zimbabwe and Great Britain. Since the Treasury cannot sell its long-term debt at low yields (under 4%), bond rates have already begun to rise. In 2009, the 30-year Treasury bond yield rose from 2.69% to 4.63%. Due to these rising yields (depressing bond prices), Treasury securities posted their worst performance since the 1970s. As long-term interest rates continue to rise, the interest on the U.S. cumulative budget deficit of over $12 trillion will likely become increasingly problematic.

Rising Federal and State Budget Deficits

Last Wednesday, the Census Bureau reported that state and local tax revenues fell 7% in the third quarter (vs. the same quarter in 2008). Sales taxes fell 9% while state income taxes were 12% lower. Property taxes increased 3.6%, mostly due to higher assessments, despite falling real estate prices in most regions.

The third quarter marks the fourth consecutive quarter in which state tax collections were below the same quarter a year earlier. Through the first nine months of 2009, state and local tax revenues fell 8%. But that's "healthy" compared to the federal level. During the same period, federal tax receipts were down nearly 19%. Of course, the federal government can print money and run deficits, while most states are required to balance their budget, which implies more layoffs, tax increases and cuts in local services.

So far the U.S. government's fiscal 2010 budget deficit is running higher than fiscal 2009's record $1.4 trillion deficit. The Fed is very aware that the Treasury Department is approaching the limit of the amount of money that it can borrow without sending underlying interest rates soaring. Last Thursday, Bloomberg reported that the Fed is considering a proposal to schedule limited sales of bonds from the Fed's $2.2 trillion balance sheet as another option for withdrawing their previous monetary stimulus.

According to recently-released Federal Open Market Committee (FOMC) minutes, the Fed discussed asset sales at its November meeting, with some members in favor and others warning of "sharp increases" in long-term interest rates, since the Fed would be competing with the Treasury for capital, crowding each other out and effectively forcing long-term interest rates much higher. Instead, the Fed may try to drain reserves from the banking system, even though such a move could cause another economic downturn.

Wild Cards: Consumer Confidence and Jobs

Just when you might be wondering why I am so bullish, in light of so much bad news, don't forget that corporations run on earnings, and our "lean and mean" corporate world will report much higher earnings - they will start feeling so flush that they can start hiring, thereby lifting the spirits of consumers.

Last Tuesday, the Conference Board announced that consumer confidence rose for the second straight month as more and more Americans expect the U.S. economy to improve in 2010. The index rose to 52.9 in December, up from 50.6 in November. More importantly, the "expectations index" jumped to 75.6 in December, up from 70.3 in November. (Any reading above 50 is net positive, and 75 is very optimistic.)

Businesses are also more confident. On Wednesday, the Institute for Supply Management announced that the Chicago purchasing managers index (PMI) rose to 60 in December, from 56.1 in November, reaching almost double the level of its January low of 31.4. Almost all of the PMI components rose strongly.

The labor market also continues to gradually improve. On Thursday, the Labor Department announced that the number of people filing initial claims for state unemployment benefits fell 22,000 to a seasonally adjusted 432,000 in the week ended December 26, the lowest level since mid-2008. Economists expected initial jobless claims to stay around 455,000, so this was a clear sign that the labor market is firming up.

Also, the four-week average of continuing claims dropped 122,000 to 5.22 million, the lowest rate since last March. This suggests that companies are no longer laying off workers and may be hiring. Of course, Friday's December payroll report will be closely scrutinized for more evidence of this positive trend.

China's Rapid Growth May Trigger a Trade War

Another reason I'm positive about 2010 is that global markets continue to lead the way. In particular, China's economy continues to run circles around most of the rest of the world. China's PMI index hit a 20-month high, reporting the tenth straight month that the PMI has stood above of 50, which is indicative of an expansion of economic activity. Most (17 of 20) of the industries surveyed in China reported expansion, with metal products being the strongest and tobacco being the weakest (a positive trend!).

China reported an impressive third-quarter GDP growth of 8.9%, and it now appears that China is on track for even faster GDP expansion in the fourth quarter of 2009, and 2010. Clearly, China remains the strongest major economy in the world and is helping to boost economic growth throughout the world.

The wild card is how the U.S. responds to this growing imbalance of trade and growth. Sadly, the U.S. continues to escalate its trade war with China. Last Wednesday, the U.S. International Trade Commission (ITC) ruled that the domestic steel industry had been "damaged" by subsidized steel pipe from China. U.S. steelmakers claim that "unfair" Chinese pricing caused a layoff of 3,000 workers, so industry leaders were pleased with the ITC's ruling. As a result of this unanimous ITC ruling, duties ranging from 10% to 16% will be imposed on future imports of Chinese steel pipes (often used to extract natural gas and oil).

But China is not so pleased. An official in China's Ministry of Commerce said that China "resolutely opposes" the ITC ruling, saying retaliatory action is possible. Chinese steelmakers already have excess capacity and cannot automatically funnel it all to Europe, since the European Union and steel producers in Europe have also taken actions against China. This is a big escalation in trade war rhetoric, since the steel pipe market dwarfs previous skirmishes over chickens, tires and cars. China says this tariff sends a "wrong protectionist signal." Trade wars are clearly escalating and remain a threat to the global recovery.

Bottom line, I'm bullish, but the "wild cards" remain trade war abroad and consumer confidence at home.

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