By Benjamin Tal

The news of late has been undeniably positive. But the road ahead still has a few more bumps than currently anticipated by the market. Governments all over the world will stop spending and some, in fact, will start tightening their fiscal policies. Central banks will start removing liquidity from the system and interest rates will start rising in the second half of the year. Deleveraging by consumers will continue to limit the ability of households to shoulder a strong recovery, and American banks will still have to deal with massive losses due to their existing exposure to Alt.A and Option Arms mortgages as well as the fragile commercial real estate market. Add to it the real risk that Dubai and Greece’s current troubles represent a potential wave of sovereign debt problems and you have a good reason to believe that the easy money in the stock market has been already made.

Making money in 2010 will be much more difficult. And the theme will be conservative investment. In fact, in many respects, the nature of demand will determine the relative valuation of the stock market. The vast majority of the cash sitting on the sideline in both Canada and the US is concentrated among people age 55 plus. These are also the people that now return to the labour market in order to compensate for the significant loss of wealth they have encountered in the past two years. Given the experience of the recent past and their age profile—these investors’ style will be defensive in nature.

In practical term this means that new money will flow into two main destinations. The most attractive target will be solid and established companies that pay relatively high dividends. This is a typical play for conservative investors that are unsatisfied with a GIC type investment. In Canada, dividend seekers have always looked to telecoms and utilities for healthy dividend yields, and those two sectors indeed top the pack in terms of TSX payout ratios. But there are other groups where dividends now pay out 4% or more of the share price, including real estate, media, banks, and health care. The second group of interest might be fixed income investment in general, and corporate bonds in particular, due to the pervasive focus on capital preservation and the realization that any near-term inflation risk is minimal.