Trying to pick winning stocks is always difficult. Despite a waning financial crisis and nascent economic recovery, conditions in 2010 appear unlikely to make it any easier. Bloomberg BusinessWeek asked portfolio managers and other investing professionals for their views on the market in 2010—and their top stock picks for the year. Earnings, the economy, and interest rates topped their concerns. Most investors in our survey expect stocks to end 2010 with gains, although few dare forecast specifically where the market will end up. The diversity of the individual stocks they've selected, as you'll find in the accompanying slide show, reflects wide-ranging views on the factors that will influence the market. For example, there is uncertainty about when the Federal Reserve might raise interest rates. (By keeping short-term rates near zero, the Fed stimulates the economy but also raises inflation fears.) On one hand, the U.S. economy is showing signs of life. On the other, unemployment remains high and the country's financial system needs low rates to heal damage from a credit crisis that hasn't yet ended. "Can the financial system ride this bike without the training wheels?" asks Michael Church, president of Addison Capital Management. "I'm not sure the answer is yes." Rising rates could be dangerous for those heavily invested in bonds. "If we begin to see central banks raising rates, then we are going to have a rather negative environment for fixed income," says Walter Gerasimowicz, chief executive of Meditron Asset Management. Investors seek demand, not more cutsThe Fed's moves in 2010 will be determined by the economy, which is also a key factor for shareholders who are trying to predict corporate profits next year. In 2009, many companies boosted profits by reducing expenses, in part through steep job cuts. But to continue posting profits that impress Wall Street, "we really want to see a resumption of demand," says Michael Alpert, a portfolio manager at Seligman Investments. With more than two-thirds of the U.S. economy focused on the consumer, many worry that unemployment is hurting demand, even as the economy begins to recover. Although the holiday retail season isn't over, results and traffic have not so far impressed investors, says Robert W. Baird senior retail analyst Erika Maschmeyer. Results have been "a little below expectations that were too lofty," she says. "As we head into 2010, the big questions are how fast this economy is recovering and what can be done to get 10% of the workforce back to work," Alpert says. While most investors expect the economy to improve in 2010, the pace could be frustratingly slow. "I don't see any strong recovery," says Barry James, president and portfolio manager of the James Advantage Funds. "Call it 'bumping along the bottom.'" "an inordinate amount of pessimism"However, Thyra Zerhusen, portfolio manager of the Aston/Optimum Mid Cap Fund (CHTTX), has been meeting with executives recently and hears optimism. "They're seeing business picking up," she says. "When business comes back, there could be surprises." Thomas Villalta, co-portfolio manager of the Jones Villalta Opportunity Fund (JVOFX), agrees. "There is an inordinate amount of pessimism in the market today," he says. As demand picks up, new revenues will be especially profitable because of the cost-cutting that companies undertook in the past year. An improving economy will cause both consumers and companies to start spending again, which should benefit technology and consumer discretionary companies. By contrast, more pessimistic investors emphasize the extent to which credit issues will constrain the economy, even as it recovers. For example, Kim Caughey of Fort Pitt Capital Group is buying companies with exposure to emerging markets, which lack the U.S.'s fundamental problems with debt. The tough credit environment should also favor larger companies over smaller ones, and those with good balance sheets over those with lots of debt, she says. All this uncertainty and disagreement could lead to a volatile stock market in 2010. The next year won't be "for the faint of heart," James says. "You're going to have to be nimble." The volatile markets of 2008 and 2009 complicated stock picking. Prices of many issues swung wildly, based not on their individual attributes but on broader forces in the market and economy. Some hope conditions could improve in 2010 for bottom-up investors. In 2010, "I think quality will matter," Alpert says. "We're going to get back to a fundamental, stock picker's market". Wall Street may provide extra rewards to companies that can stand out from their peers by delivering strong results next year. Investors still face the task of identifying precisely which companies will deliver and which will disappoint in 2010. See the accompanying slide show for recommendations of 16 companies that could profit in the New Year.
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