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Five Reasons Why Stocks Will Be Higher In 2009

Sunil Bhardwaj, MBA, CFA
Private Client Investing
CIBC Wood Gundy

Good riddance 2008. That is one old acquaintance we would rather soon forget. Equities posted one of the worst years on record, with the S&P/TSX Composite Index falling 35%, the S&P 500 sliding 38% and the MSCI World index plummeting 42%.

As last year's market declines continued seemingly endlessly, investors who could no longer bear to see their investments sink further moved to the sidelines. Some even moved their money into guaranteed investment certificates (GICs) that offered paltry yields. These investors clearly have given up on investing in stocks, feeling that the risks outweigh the benefits.

Looking to 2009, there is no doubt the economy faces great challenges. Unemployment is rising, housing prices are falling, and global economies are struggling to keep GDP growth rates from slipping into the red. With this backdrop, why would one want to invest in stocks? While we would not count on a quick rebound to 2008's peak levels, we offer five reasons why major stock market indices should be higher by year's end than where they were when the year began.

1) Markets turn before the economy

Stock prices typically reflect expected future earnings, not past results. As evidence of this, the S&P 500 began its retreat in October 2007, more than a year before the official declaration of a U.S. recession. The same will likely be true on the upside. In the last consumer-led U.S. recession, the S&P 500 rallied more than 25% from its October 1990 bottom, well before the economy began a turnaround in March 1991. In 1982, the rebound was even more dramatic, as the market rose more than 35% before that recession ended in November of that year. Look for the next bull market to start in earnest sometime in mid-2009. Until then, stock markets may still trend upward, but they might do so in fits and starts.

2) Stimuli, stimuli, stimuli.

Confidence seems to be building with the nearly US$2 trillion in international stimulus packages that are being planned by global governments. In addition, central banks seem locked in a race to see which one can cut interest rates the fastest. These efforts will have a lagged economic impact, but confidence-building can help stock markets.

3) Selling pressure likely to ease.

One force depressing stocks in the fourth quarter last year was mutual fund and hedge fund redemptions as investors pulled massive amounts of money from funds in a bid to avoid further losses. This reinforced the downtrend as money managers were forced to sell stocks to raise cash. The peak in mutual fund redemptions appears to have passed, which should alleviate some of the selling.

4) Valuations are compelling.

Recession or not, many well-run companies with reasonable debt levels will survive this downturn - although their stocks seem to be pricing in a sustained earnings depression. Once investors begin to see the light at the end of the tunnel, they may begin to look past the lowered earnings expectations for 2009, and think again about earnings growth in 2010 and beyond.

5) Dividend yields alone should outpace T-Bills and GICs.

Risk-averse investors have flocked to government bonds and GICs like never before. The three-month U.S. Treasury Bill shockingly traded with negative yields in December. The dividend yield on the TSX now stands at 4.64%, more than 184 basis points above the yield on a 10-year Government of Canada bond. Even if stock prices remain flat for the next 10 years, it appears equity investors will still be ahead of bondholders, particularly in light of the favourable tax treatment on dividend income.

Investing in stocks has been, without question, difficult over the past year. Looking to the future, however, 2009 should mark the beginning of a return to long-term positive equity gains.

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