So Long 2009!

The tone of much of the year was one of fear as the bear market, which
began October 2007 and didn’t quit until March 2009. Those 17 months, witnessing
a 57 percent decline in domestic stock prices, proved to be the second deepest
bear market in the past 80 years. Though the market is still 29 percent off its
October 2007 peak, it performed admirably in 2009, gaining 26 percent.

The year was marked by capital infusions, bailouts, stress tests,
frozen credit, bank failures (148 in 2009 and 26 in 2008), anti-Wall Street
backlash, record federal deficits, corporate cost-cutting, home foreclosures
and job losses.  By the second half
of the year investors started to breathe easier and believe that the 2008
recession wasn’t going to double-dip into a deeper recession in 2009.

The healing process was shaky but by the
fourth quarter the numbers became more convincing. Retail sales, manufacturing,
business inventories, and housing data all remained anemic through the year but
the data began indicating some real, albeit small, improvement.  The GDP numbers currently tell us that
the recession that began December 2007 will likely be considered ended by the
end of the second quarter 2009. Economists expect GDP growth to reach 2.6
percent in 2010.

Recovery is certainly not a fait accompli. The economy
continues to be a hardship for so many people struggling with unemployment.
While the official unemployment numbers reached 10.2 percent, the real numbers
hover closer to 25 percent as many have stopped looking for jobs and many have
settled for temporary work away from their typical occupations. Companies
remain incredibly cautious; they are risk averse, lean and fearful of spending
to expand production and build up inventories.  Additionally, banks have yet to prove that they are ready
and willing to lend again. Businesses began increasing their inventories
slightly in October; that was after 13 months of consecutive decline. Hopefully
that will prove to have been the beginning of a new phase in the business cycle
where businesses begin restocking their shelves and kick-start manufacturing
and job creation.

What’s Ahead for 2010?

I believe the domestic stock market will continue to rise in
2010.  However, since I was
surprised by the strength of the rally off the March lows and the fact that
there was no meaningful correction along the way, I expect a considerable amount
of volatility in 2010.  The economy
is improving and I expect companies to begin hiring again by mid-year, and I
see three forces driving stocks up: economic recovery (jobs, consumer spending,
lending), investment returns (low income returns from fixed income securities),
and investor sentiment (most investors still don’t trust the market and that
will change).

There is value to be found in stocks in every economic sector but
money flows should favor Technology, Healthcare, Energy, and Consumer Cyclical
stocks the most.  A few investment
themes are:

Technology: New business investment and novel developments such as
cloud computing.

Healthcare: Post reform relief and increased population coverage.

Energy: economic recovery and alternative energy sources still years
away.

Consumer Cyclical: job recovery and improved consumer confidence.

I have always advocated that a healthy portion of all investor
portfolios, regardless of age, be allocated to bonds, and that hasn’t changed
even though I do not expect much from bond returns in 2010.  Bond holdings should include short and
intermediate-term maturities of high quality corporate bonds,
Treasury-Inflation Protected bonds (TIPS), treasury bonds and, depending upon
your tax bracket, municipal bonds.

In 2010 I plan to increase allocations to emerging market stocks as I
expect to see countries in Asia and Latin America experience faster growth than
developed ones.  Though the dollar
may strengthen a little in the coming year, commodities, especially agricultural
based ones, should continue to do well. I do not expect gold to outperform
stocks in 2010. 

Having said all of the above, I always expect the unexpected and
continue to maintain a healthy skepticism and vigilance towards managing risk.

One final note about the last decade: Media reports state that the
market declined 24 percent over the past decade. That ignores dividends. The
cumulative total return (price change plus dividends) over the last decade was
a decline of 9%, which is not good but is significantly better than 24 percent.
Furthermore, the average annual total return for each of the last ten years was
.12 percent or virtually flat each year.

I wish everyone a happy, healthy and prosperous 2010!

* I look forward to
receiving your questions about anything related to investments, retirement
planning, or the economy. Send them to: [email protected] and write
“Chadds Ford Live” in the subject line.

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