Last November, Federal Reserve officials projected that the U.S. economy would expand at a slow rate in 2010. Not everyone agrees; and the surprise is that many market strategists are more optimistic than the Fed. "We think the economic outlook will be better than the consensus forecast," says Paul Zemsky, New York-based head of asset allocation and multi-manager investments for ING Investment Management. "We look for unemployment to reach its highest level in the first quarter of 2010 and then start to drop. Economic growth for the year might be 3% or higher."

Zemsky's optimism is based on a forecast that includes an improved housing market, a pickup in consumer spending, a recovery in business investment and continued fiscal stimulus from federal government initiatives. "We could see a better economy, better earnings and a better credit market," he says. Indeed, U.S. home prices improved in the second and third quarters of 2008, according to the S&P/Case-Shiller Index, providing hope that the housing market (and the U.S. economy) has seen this cycle's bottom.

According to the strategists interviewed for this article, 2010 looks like a good time for investors to take some risks, but not bet the farm. Low-risk alternatives, such as bank accounts and U.S. Treasuries, offer scant returns, they say; instead, moderate-risk vehicles, such as large-cap stocks, corporate bonds, munis and commodities, belong in clients' portfolios now.

STICKING WITH STOCKS

Slow or not-so-slow, most analysts are looking for economic expansion in the United States and around the world this year. Worldwide, government stimulus programs have helped to calm fears and boost confidence; in many countries, expansion is already under way. Economic growth is likely to boost corporate profits and may continue the stock market surge that began last March.

"I would definitely keep investing in equities," says Bob Froehlich, senior managing director in the Chicago office of Hartford Financial Services. "At some point in 2010, profits may no longer come mainly from cost cutting and productivity improvements. Top-line revenue growth may be added, which should help to sustain the rally in stocks." According to Bloomberg, corporate profits climbed 21% from January through September, the biggest nine-month gain in five years.

The consensus seems to be that domestic issues are less promising than foreign ones and stocks from emerging markets in particular. "Emerging markets remain the investing story of our time," says Erik Ristuben, chief investment officer with Russell Investments in Tacoma, Wash. In Russell's most recent survey of more than 200 investment managers, as of the end of the third quarter of 2009, 67% were bullish on emerging- markets equities, while 63% were bullish on stocks from developed markets outside the United States, he says. By contrast, bullishness on U.S. stocks ranged from 49% (for mid-cap value) to 59% (for mid-cap growth).

Why are emerging markets so appealing? "The emerging markets have asserted their economic independence during a challenging time in the United States," Ristuben says. "Investors had feared that emerging markets would suffer even more if the United States hit a rough patch, and that may no longer be the case."

Zemsky explains, "Emerging markets are a leveraged play on growth." As the worldwide economy recovers, emerging markets should grow faster than the developed nations because they have more people moving up to middle-class lifestyles, exporters to sell products to industrialized countries and, in some cases, commodities-based economies that will benefit from rising demand. Predicting further pressure on the U.S. dollar, Zemsky recommends a 2010 portfolio that's overweighted in international stocks, with the expectation that emerging markets will outperform developed foreign markets.

The emerging markets of Asia, particularly China, Korea, Singapore and India, may be especially appealing, according to Froehlich, who would place as much as 60% of an investor's equity allocation in foreign stocks. "China and Korea recently have reported double-digit growth rates," he says. By comparison, U.S. economic growth in the third quarter of 2009 was first reported at 3.5% and then revised down to 2.8%.

Inside and outside the United States, Froehlich prefers large-cap multinational stocks. "Investors are still nervous after being whipsawed in recent years," he says, "so they probably will gravitate to companies with strong balance sheets and names they know." Moreover, multinationals may have substantial exposure to the economic growth expected in the emerging markets, with fewer risks.

SUPERIOR SECTORS

In the Russell survey of investment managers, technology was far and away the leader, with a bullish rating of 78%. According to Ristuben, this is the most bullish rating for any equity sector since Russell began its survey of investment managers. Generally, both consumers and businesses can be expected to spend more money on technology in an expanding economy.