The markets' artificial high will wear off

World governments' stimulus measures were a massive a boon to asset markets in 2009. The big question now is what will happen as the money is gradually withdrawn.

In 2009, markets ran on "steroids", says Jeremy Warner in The Daily Telegraph. The MSCI World index of developed market equities is up by more than 70% from its March low. The S&P 500 gained 65% from its low and finished the year 23% ahead overall.

Central banks and governments have cut interest rates to zero. They've also committed around $30trn in printed money, debt guarantees and fiscal stimulus packages to alleviate the impact of the credit bust, says Sddeutsche Zeitung, racking up huge public debts in the process. The unprecedented liquidity has been a boon to asset markets. The big question for 2010 is how economies and markets will fare as the money is gradually withdrawn.

The key problem is that equity markets are looking forward to a robust recovery. Yet banks, especially in Europe, "remain undercapitalised and incapable of providing sufficient credit to sustain a normal upturn", says John Plender in the Financial Times. And Britain and America can't count on domestic demand to fuel growth as overleveraged consumers are rebuilding their balance sheets. "Much of the adjustment" to both private and public balance sheets still lies ahead, says Warner.

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Even so, analysts are pencilling in a "decidedly v-shaped" earnings recovery, with US and European profits expected to expand by 33% and 25% respectively in 2010, says Nicholas Paisner on Breakingviews. Forecasts will be "hard to beat".

It's interesting to note in this context that most boards of companies in Germany's DAX 30 index feel the outlook is so uncertain that they don't want to make a forecast for 2010 or 2011, says Wirtschaftswoche. Valuations are another headwind; the S&P is almost 40% more expensive in relation to earnings than its long-term average, says Capital Economics. So one threat to markets is that the recovery is likely to disappoint.

But good economic news could also be a problem, says Paisner. If growth picks up, investors will start to worry about interest-rate hikes and higher bond yields, with the latter making shares look less attractive than bonds. There's also the danger that the Federal Reserve might have to raise rates more sharply than expected to counter a jump in inflation, says Neil Hume in the FT. There are too many potential pitfalls for investors to count on the modest increase in share prices that analysts expect in 2010.