Friday, January 7, 2011

2010: The Year in Retrospect

A) 2010 was a year characterized by two "seasons". In the first half of the year from January through June, the S&P 500 was negative 7.87%. From July through December, the S&P 500 was positive 22.41%.

B) The month of December saw the S&P 500 gain 4.28%. This is equivalent to an annualized return of 51.36%.

C) From March 6, 2009 to December 31, 2010, the S&P 500 rallied 84.03%.

D) Putting these returns in context, it is important to appreciate that from March 31, 2000 (almost eleven years ago) to December 31, 2010, the S&P's performance is negative 16.08%, and that is after including all the above referenced rallies.

E) Another sobering fact is that the S&P 500 last made a high on October 5, 2007, and from this date through December 31, 2010, the index is negative 19.26%.

F) Over the last fifty years, the S&P 500 has been up 53% of all days and down the other 47%, as documented by BTN Research.

G) Domestically, small cap stocks were the leaders for the year over every other major asset class. Alternative energy and solar in particular was one of the worst performing sectors.

H) In addition to commodities, the real winners in 2010 were emerging markets. In particular, Peru, Thailand, Chile, Philippines, Indonesia, Malaysia and South Africa showed the greatest strength in descending order per Dorsey Wright's January 4, 2011 report.

I) With respect to currencies, 2010 was again a year of two halves. The first half witnessed a rise in the U.S. Dollar, but in the second half it fell, erasing most of its prior gains. The Australian Dollar and the Japanese Yen were the strongest currencies for the year. In contrast, the Euro and the British Pound were the weakest currencies per Dorsey Wright's January 4, 2011 report.

Short Term Risks Heading Into 2011

A) Currency wars present unusual risks that are not easily calculated. There is sort of a tug and a pull when it comes to manipulating currencies. To stimulate exports, countries seek to weaken their currencies. However, when currencies become too weak, that can undermine investment into the economy. Chile represents this dilemma perfectly today. According to Siobhan Morden, a Latin American strategist at RBS Securities, Inc., Chile has practically no debt and no fiscal deficit. Chile is the world's largest copper producer, and the surge in copper prices has resulted in a much stronger Chilean Peso. Just recently countries such as Chile are selling their home currencies on the open market, and using the proceeds to buy US Dollars, so as to puff up the relative value of the greenback. Considering that most commodities and other global products are priced in US dollars, this type of currency manipulation could result in dramatic and quick reversals from emerging markets which have been on a tear in the last year.

B) The impetus for the market's second half year surge is the Federal Reserve's commitment to buying back government bonds. With improved statistics and optimism, it is more likely that future economic stimuli will be halted. In fact, there is a risk that the US might move closer to European austerity measures if it is perceived that the storm is over. Also food prices are at inflation adjusted all-time highs, and gas prices are steadily increasing, both of which can cause a drag on the economy.

C) Warren Buffett advises to be greedy when the majority is fearful, and to be fearful when most are greedy. At the start of 2011, 63% of retail investors are bullish, as reported by the American Association of Individual Investors. And the most recent survey by Investors Intelligence shows that advisors are now more bullish than at any other time since the peak in October, 2007. These are very bearish indicators. The best time to buy stocks is when no one else wants them.

D) The weakness in the economy resulted in unprecedented strategies to grow the economy. These have not been normal times. In fact, a new term has been coined for this period as the "new normal". Believing that companies were too big to fail, governments around the world have been changing the standard rules. There has been anything but certainty in the last two years. We have kicked the can down the road by borrowing. The analogy that comes to mind is the festive holiday shopper who overspends in December by putting more and more on his credit cards. There is exuberance at the holidays, but reality sets in in January when all the bills arrive. The problems which created the great financial meltdown were brewing for a long time before they were recognized, much less erupted. As comforting as it may feel to convince ourselves that everything is now behind us, we still need to face the music about how to unravel the mass of global debt. I am sorry to say that it will not all be pretty. This is still a market that requires 'rowing" strategies, notwithstanding the fact that the majority believes it is time for clear sailing. I have both my oars and sails on board. Stay tuned.

The Standard & Poor's 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

International and emerging market investing involves special risks such as currency fluctuation and
political instability and may not be suitable for all investors.

The prices of small cap stocks are generally more volatile than large cap stocks.

The opinions voiced in this material are for general information and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, you should consult a financial advisor prior to investing.

Past performance is no guarantee of future results.