A New Year!

As we enter the new year, we look back at a 2010 that certainly did not leave us short of material to talk about. We experienced a stock market ‘flash crash’, a financial crisis in Europe, a conflict in Korea, tax uncertainty, QE 2 and an upset election to name only a few.  In a year that had its share of ups and downs, patient investors did not miss out. The first half ended firmly in a correction as investors tried to digest the meaning of the credit crisis in Greece and what could be expected from the sluggish US economy.  By midyear the Dow Jones had fallen well below 10,000, but a market rally in the third and fourth quarters more than made up the lost ground.  At the end of the year, the S&P 500 was up 15.1% marking the second year of double digit returns.

Most of the broad market’s fourth quarter gain came in December as the government’s stimulus package, which included a second round of quantitative easing and extended tax breaks, gave investors something to smile about.  In the US, small and mid-sized company stocks performed best for the quarter, returning 16.3% and 13.1% respectively, while the large company stocks posted a solid 10.8%.  Among the Standard and Poor’s sectors there were clear winners, including energy and material stocks up 21.5% and 19% respectively.  The laggards included utilities, which returned 1.1%, and healthcare stocks, which returned 3.6%.  Overall the European markets did not fare as well as the US, with Portugal, Italy, Ireland, Greece and Spain dampening the returns even though Germany fared well enough to bring the broad European benchmark up 6.2% for the quarter. 

The emerging market index had another strong year ending up 19.2% but underperformed the US and European benchmarks for the fourth quarter. China’s action to control inflation held the Chinese market back, however, markets in India, Indonesia, the Philippines, Malaysia and Thailand all rose to record highs making the emerging markets one of the most talked about investment themes of 2010.  The gold story was arguably the most popular theme of 2010 after a multi-year run that brought gold over $1400 per ounce.  What hasn’t been talked about as much is that nearly all commodities experienced big price gains.  For the year, gold went up 29%, Palladium rose 95.6% and cotton’s price increased by 91.5%.  We will continue to watch commodities both as an investment theme and in terms of its impact on the developing countries and inflation.  To date, inflation has been relatively tame, but if the cost of commodities continues to rise this fast, it will surely have an impact both on the prices of goods we buy as well as the ability for developing countries to continue their rapid growth.

After two years of strong calendar returns, there is renewed optimism and a consensus that things are pretty good.  Many troubling issues such as unemployment and retail consumption have shown positive trends that made investors feel confident about the economy’s direction. We must be reminded that even with rising markets and stabilizing economies, there are clouds that linger.  Charles Schwab’s Liz Ann Sonders reminds us that there are still elephants in the party room.  She suggests that with investor sentiment leaning so bullish, the market is vulnerable to bad news and notes a pullback is probably overdue.  Robert Doll, Chief Equity Strategist at BlackRock, has a somewhat different opinion of the market.  He believes the economy will plod along. but instead of a market pullback, he forecasts a continued strong run for stocks through 2011. 

There are significant risks that remain and they are well known. We don’t have to look further than the housing market to see a risk to our economy.  Home prices have been largely propped up with buyer incentives that are now expired and low interest rates that will not be with us forever.  A stronger recovery will be held back by the speed of the recovery in this important sector. The other large concern is the debt-laden state of our governments.  One of the reasons we’ve been recommending a portion of fixed income to the global bond sector is the access to countries that don’t have the debt levels of the US and much of developed Europe.  Austerity may be the word of 2010, but it will take time to bring deficits to a sustainable level both here and abroad. 

Investors have many reasons to be optimistic but should be realistic about risk and volatility.  If we look at the chart below, we can see risks over the past forty years that could have kept investors waiting until a better time. Risks in the market are never going to completely go away, and waiting until things improve usually means losing out on return. 

Wally Weitz, the head of the Weitz Funds, wrote his December commentary titled “Changing Changelessness” referencing the fact that no matter how many times prognosticators say ‘this time is different’, patterns of the past re-emerge, or as Mark Twain said, “History does not repeat itself, but it does rhyme”.   There are and there always will be situations that create uncertainty, but there are plenty of opportunities to be found in today’s market.  Our goal is to create an investment portfolio that takes advantage of the market’s opportunities, but even more importantly, we strive to meet your individual objectives. For many clients that means building a portfolio around your cash-flow needs.  Adjusting the allocation enables us to work through the unsettled times.  We will continue to raise cash from time to time to smooth out the bumps.  Our philosophy is to provide a safety cushion no matter which direction the market is heading. We look forward to helping guide you through the many changes in 2011.