Montreal, Canada

Forecasting is largely a mug's game since most investors fail to get it right consistently – including myself. Market timing falls into this space and Warren Buffett refutes trying to time an investment. Yet it seems painfully clear to me that the "buy and hold" era has come and gone with stocks barely beating bonds since 1970, according to research courtesy of The Bank Credit Analyst.

The 2000s belonged to gold, commodities, foreign currencies, bonds and the emerging markets. Just about everything else posted a decline over this stretch or failed to produce a meaningful gain adjusted for inflation.

With the end of the decade now just days away it's always fun to make predictions for the next 12 months. If anything, I hope these ideas and forecasts will serve as food for thought and help you structure a diversified investment plan for 2010.

Interest Rates

Every investor wants to know about interest rates. Rates influence the way we plan our investment purchases, sales, portfolio outlook and for retired individuals, the difference between a few bucks and a bundle depending on the interest rate outlook.

In 2010 the Federal Reserve will keep interest rates unchanged. Longer term rates, which are not influenced by the Fed, have begun to ratchet higher since last week but won't move much higher beyond 4.25% or 4.50% on the ten-year Treasury bond. That's a big move from current levels.

Right now the best bond trade is TBT, an aggressive inverse bet on long-term T-bonds. The trend is higher rates heading into 2010 and TBT recently broke-out of its range.

Assuming the correction in bond yields continues this winter, investors might do well buying Treasury bonds next spring or summer ahead of a severe stock market pullback or worse; the market is expecting a significant recovery in 2010 and prior recessions this deep have typically resulted in big gains for the economy. I'm not so sure we'll see a sustainable recovery beyond a quarter or two; there's an enormous amount of slack in the economy and nobody is raising prices. The consumer might also come back for another hurrah but that game is largely over as Americans accelerate personal savings at the expense of profligate spending. Wages remain in a downtrend and that's also bearish for spending.

I'd keep my fixed-income maturities super-short (2 years) and roll over my cash using a laddered portfolio of 91 day bills, six-month bills and 12-month bills. You don't get much but at least it beats a money-market fund after fees.

The Fed will be pressured to tighten but I'd bet it won't happen unless employment growth surges over the next several months. If you own Treasury bonds, keep your maturities short or buy funds with someone at the helm that knows what they are doing – like the PIMCO Total Return Fund. Avoid long-term bonds for now.

At some point over the next 3-5 years another crisis looms. This time, a currency and/or debt crisis will confront the government as some sort of creditor backlash develops over U.S. out-of-control spending. That event is likely to push rates much higher and possibly tip the economy back into another severe recession or worse. It might also jettison some sort of VAT, or Value-Added-Tax, by Congress or a deficit reduction tax. Unless something is done to restrain U.S. spending this scenario is inevitable. If the government doesn't remedy this situation then the markets will. Longer term, I remain very bearish on bonds – especially long bonds.

Stocks

Stocks were cheap last March at the market low but not exactly the values that existed in prior economic crises or recessions (e.g. 1990, 1981, 1974, 1932). After gaining almost 70% over the last ten months I'd say equities are overvalued and due for a serious 15% to 20% correction in 2010.

If interest rates continue to climb higher over the next few months I'd have a hard time supporting the consensus view that equities can compete with bonds in a sluggish economy; stocks barely yield 2% again while bonds are yielding more with every passing day. Also, corporate insiders have been dumping stocks en masse since August – there's got to be something to be concerned about if these guys don't like their own company shares. Are they wrong about the economy or just taking money off the table? I think it's the former.

Corporate earnings need a vibrant consumer. So, if you believe that the average consumer won't return to his pre-2008 dizzy spending ways going forward then earnings won't find any support. Thus far, earnings have recovered mostly on the heels of massive corporate cost-cutting (aka lost jobs) and inventory reduction. How long can this continue in the absence of a vibrant consumer-led recovery?

Retailing in the United States is a bad business. Going forward, I think many chains and specialty stores will shudder while discount stores like Family Dollar and Dollar Tree will flourish. Americans are becoming fugal again. They don't need 15,000 Gap stores or auto dealers on every block.

What's also worth noting is that America's largest companies that comprise the S&P 500 Index are sitting on mountains of cash – about $1.3 trillion dollars. Cisco Systems alone hoards about $30 billion in cash. Over the last six weeks investors have been rotating from small-caps to large-caps; that's the kind of leadership that is symbolic of an exhausted market. Small stocks lead a recovery while large-caps lead the last legs of a rally.

On an encouraging note, mergers and acquisitions are heating up again and that's good news. Deals are bullish because they emit a positive economic outlook from some industries and companies. But for the most part deals are occurring without speculative finance capital (venture funds) and are largely within the confines of the big boys, not small companies. Banks aren't lending to small businesses.

For stocks in 2010, I'd be hedged. This means I won't be fully exposed to the stock market and instead, hold a mix of long-only stocks and reverse index funds and a bit of the VIX. I'm holding shorts on the S&P 500 Index, the German DAX and Chinese equities and getting killed; but I won't invest in the market without hedges or insurance protection.

On the long side I hold U.S. utilities, Japanese large-cap stocks and several food and beverage names like McDonald's and Nestlé. I also hold gold stocks and energy stocks, too. But overall, my net exposure to equities remains the lowest it's ever been and that's just fine with me.

My greatest concern – and I have many – is that I don't believe we've seen the worst yet. There was such a massive credit overshoot heading into 2008 that it seems unbelievable that the payback cycle is over. There's still an incredible overhang of debt in the financial system and recent flares in Greece and Dubai are peripheral events that are symptomatic of a sick global economy. Other countries will follow.

My forecast for global stocks is an extension of this post-March party until spring, possibly sooner. At that time, a severe correction will drown the market as stocks tank 15% or more quickly. Some sort of Black Swan will unleash a new wave of uncertainty and quash the ongoing bullishness. Stocks will finish 2010 with a loss – ranging between -5% to -10%.

In part two, tomorrow, I will share my thoughts on commodities and currencies.