What risks and opportunities do you see for 2010?

Looking forward, here are the risks factors that investors should take note of in the current market environment. 

1) Tensions between countries worldwide can introduce protectionism measures (such as U.S. hitting China with fat taxes on tires and China slapping import duties on American chickens) amid this weak econo...my. The recent Toyota recall in U.S., the hacking of Google website in China, and the pressure to allow renminbi to appreciate are some examples of issues that may intensify global relationships.

2) Banks still have a huge “shadow inventory” of foreclosed homes that they are holding off the market. Releasing them can further depress home prices.

3) Banks are not lending and credit market remains extremely tight, especially to home buyers, small business owners, and consumers. How the credit market plays out will be important to the growth of our economy in 2010.

4) The Fed balance sheet is already at $2.24 trillion and at some point the Federal Reserve will have to end its asset purchasing programs that have helped decrease borrowing costs.

5) The federal funds rate already hovers around 0% and there is really no more room to go down. Any upward adjustments can choke off economic growth and a higher interest rate environment will also not translate well for real estate.

6) We will be faced with a fading fiscal and monetary stimulus. It could mark the official real test of how our economy will fare after the initial jumpstart by the government.

7) Many countries worldwide are high in debt and how they plan to pay (or not pay) them will affect the dynamics of this global economy and impact various markets such as currency, debt, commodity, and stock.

8) Investors are currently very bullish on the market. Many believe that they have missed out on great investment opportunities in 2009 by not buying at the March bottom. Blind optimism can be a sign of speculative bubble.

9) The price-earning (PE) ratio at the end of 2009 for the S&P 500 was at 24.3. On a PE valuation basis, that’s the most expensive since 2002. Historical average is around 15.

10) The unemployment data is masking more darkness in the labor market. We were recently at a 24 year high in unemployment as the rate stood at 10% at the end of 2009 (currently at 9.7%), and what is preventing it from going higher is the erroneous way in which we calculate real unemployment. The basic formula for calculating unemployment rate is Unemployment Rate = (Unemployed Workers/Total Labor Force). The problem with this formula is that a worker must be actively looking for employment to be considered in the labor force and counted as unemployed. Workers that are discouraged and not actively seeking a job because there are none available are not considered unemployed. Moreover, people who are working part-time or as contractors are considered employed, even though their wages are just a fraction of their regular pay. Factoring in discouraged and part-time workers, the “underemployment” rate rose to 17.39% at the end of 2009.

Despite a bleak economic picture above, I believe that different opportunities are available at different times.  After all, there is a known saying that opportunities tend to coexist with risks.  Below are investment opportunities that I currently foresee for 2010.

 1)      Gold was my biggest holding in 2009 and I continue to see price growth opportunities in the precious metal.  Various reasons have been discussed in previous writings and The Strategist's Mind.  Additionally, any surprise move by the government to increase stimulus measures can boost the metal price.  I believe there is a pretty solid chance of this happening as our economy is still not fundamentally strong enough to stand on its own feet.

 2)      Quite a few non-cyclical and recession proof companies are currently undervalued.  Companies that prosper at slow economic times were unduly punished during the financial crisis in 2008 along with banks and other cyclical companies due to an increase in asset class correlations across the board at times of crisis.  These companies also did not experience as much growth as many cyclical companies did in 2009.  Investors have been pricing in a high growth economic environment in the near future and thus companies that thrive in such an environment have outperformed.  However, I believe that it was largely a misinterpretation of economic outlook and we will see various stocks valuation being adjusted this coming year.  Companies such as Wal-Mart, Pfizer, Devry, Apollo, and Bristol-Myers have solid investable value going into 2010.  

 3)      I continue to be bullish on Asia as I believe that the economic landscape of the region is opportune to benefit from the restructuring of the global economy.  However, I remain cautious in the short term as Asian stocks have experienced a sharp run up as well in 2009.  Also, the American consumer factor can still negatively impact the region in the short term.  But over the longer term, I believe that Asia, especially China, still has plenty of room for healthy growth. 

 4)      Short-positions may be used to adjust portfolio risk.  While they appear to be risky investments, they do play an important role in strategically managing volatility and will help achieve a higher risk adjusted return.  A good way to establish a short position is to buy bearish ETFs that short specific sectors.  This will cap the unlimited loss potential that exists in regular short positions.

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