After two years of solid market gains, you may be wondering what comes next. Historically, the market drops 10% about once a year, so don’t be surprised if we see a 1,200-point drop in the Dow, says Kate Warne, investment strategist at Edward Jones.  

“Over the long term, stocks tend to follow the growth of the economy and corporate earnings, which are improving. However, in the short term, investor emotion can heavily influence them. Currently, that pendulum has swung back from fear toward the center, as investors remain wary but are becoming anxious that they’ve missed out and may feel the need to be aggressive to catch up,” she says. Stocks have risen steadily since their March 2009 lows, and the S&P 500 has almost doubled in price. But periodic pullbacks are “almost certain,” Warne says. 

The good news is that the economy is back on track, Warne argues. Today’s total production is higher than its peak before the recession. Most economists expect 3% to 4% growth to continue in 2011, with a slightly slower rate in 2012. The tax cut package enacted at the end of 2010 is giving the economy a boost, and Warne doesn’ t think cuts in government spending, or oil price increases, will derail the expansion.

The economy is growing because consumers are more confident, businesses are buying new equipment, and exports are rising. Interest rates and inflation remains low at 2%. “Investors shouldn’t be surprised if begins to rise toward its long-term average of around 3% per year,” Warne says.

Almost half of the profits reported by S&P 500 companies came from overseas operations in 2010, and Warne expects that percentage to grow.  In 2010, 243 companies (almost half of the S&P 500) raised their dividends, while only four announced dividend cuts. “That’s great news for investors,” Warne says. “Companies typically don’t raise dividends unless they feel good about the future.”

The overall result is that stock returns should be close to their long-term average over the next 10 years, she says.



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