Increasingly, analysts seem to agree that the first half (and the first quarter, especially) of stock markets in 2010 will look robust and promising, but stock markets in the second half of the year leave much to be desired.

Outlook for the Canadian Stock Market in 2010

All Eyes on Japanese Debt

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According to Larry Berman, we might see the S&P 500 hit 1230-1250 early this year before it starts to decline again.  Berman sees a number of lingering risks: an unexpected downgrade to U.S. debt, to Japanese debt, or to UK sovereign debt could send the markets lower.

Japan’s debt, in particular, is at the horrendous level of 200% to GDP – and some analysts think a downgrade on Japan’s creditworthiness could be the next big shoe to drop.  We haven’t heard much about Japan beyond the use of the yen in the carry trade, but this could put a final nail in the coffin to Japan’s “lost decade.”

Either way, Japan’s savings have run out.  The aging population had saved a considerable portion of their income, but the government has spent most of it.  In terms of demographics, the European population is almost as old – and American boomers are right behind them – the first wave beginning to retire in 2011.

Berman warns that if you include the unfunded pension liabilities (Medicare, Medicaid, Social Security) on the U.S.’s balance sheets, the U.S. debt problem is almost just as bad as Japan’s.

Remaining Problems That Could Cause a Second Market Crash in 2010-2011

Rising Rates and Housing Debt Levels

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A rise in the interest rates by the Fed in the second half of the year could also be the catalyst that gives the tentative recovery its first big hurdle.  It could kill any recovery in the U.S. housing market quite easily – especially given the preponderance of option-ARM mortgages about to reset.

Berman notes that most option-ARM mortgages are underwater.  He says about 30% have no equity in them – when it comes time to refinance mortgages, there is going to be a lot of difficulty ahead if unemployment levels stay at 10% in the U.S.  There simply won’t be the aggregate spending that the markets seem to have priced in so far.

From a technical standpoint, Berman sees another small leg up on many U.S. stocks, but once a new phase of consolidation and base-making kicks in, that should be your sign to sell.  And in general, just be wary as we come closer to the second and third quarters.

Trouble Ahead With Payment-Option ARM Mortgages

The Last Shall Be First

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Emerging markets like Taiwan, Korea, Malaysia, Indonesia, India and China don’t have the aging problems that the developed world has.  Due to higher birth rates, most of their populations are quite young.  From a purely demographic perspective, Yemen, a country in the Middle East, has the best growth profile, with the youngest average population (50% are under the age of 15) and will be well poised to take part in the coming consumer boom.

Although some might argue China’s market could be overheated – they have their own stimulus bubble, after all – others simply note other Asian economies that are booming just as much as a result of trade with China – such as Vietnam, Malaysia and Indonesia.

How To Invest In India – The Only Pure Play India ETF

In sum, the risks to the U.S. economic recovery are as follows:

1. Early rise in U.S. interest rates.
2. Downgrade on U.S. or Japanese debt.
3. Unimproved unemployment in U.S.
4. Option-ARM Mortgages’ outcome.
5. Medicare and Medicaid liabilities coming up in 2011.

To this group I would also add:

6. More tampering with the world reserve currency status.

As much as I agree that, ultimately, it does not make sense for the USD to also act as the more or less official world reserve currency, it is clear that if this status were to come seriously into public question again, let alone actually changed, it would send markets in a tailspin – for what I presume are obvious reasons to my regular readers!

Of course, a change in the base rate that comes too late will also present its own set of inflationary problems.  No matter what, it seems likely that market volatility could be here to stay.  With the dawn of high-frequency trading in particular, globalization isn’t dead, but the notion of buy-and-hold appears to apply to less and less investors – or at least, take on a new meaning.

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