Taking stock

Equity markets: It's been a tough decade for stocks but a good nine months. The MSCI World index is up 71 per cent since the March 2009 low. Most equity strategists are living up to their reputation for optimism. A December 16 Reuters survey of more than 200 of them predicted that US equities will climb 9 per cent in 2010. Investors should be wary.

The market rally already looks a bit tired. While US and European shares have enjoyed a year-end rally, the world index is where it was in October. Shares have recovered about half their peak-to-trough loss. Perhaps that is as far as buying momentum will carry them.

Few bargain-seekers will be tempted. In the United States, the benchmark S&P 500 index trades at 20 times the current year's operating earnings, according to Standard & Poor's. That's bang in line with the 20-year average. With credit still constrained and government finances in poor shape, valuations should, if anything, be lower than the norm.

Higher corporate profits could drive stocks higher, but probably won't. While most economists are cautious, company analysts seem to be counting on a decidedly v-shaped recovery. They expect US and European earnings per share to grow by a third and a quarter respectively in 2010.

The recovery in financial earnings will make such growth less of an Olympian feat than it might appear. But the estimates will be hard to beat. If companies can do no more than simply meet them, especially if profits come without revenue growth, investors will not be impressed.

Good economic news could be the biggest impediment to a renewal of the stock market rally. If GDP picks up, investors will start to fear higher interest rates and higher bond yields. Shares, which are already pricing in a strong recovery, would look less appealing than fixed-income investments.

Of course, optimists can say that the withdrawal of stimulus is just a big rock in the "wall of worry" that all bull markets overcome. But this looks more like a boulder that could bring the graceful ascent of share prices to a full stop.