Grim Investment Picture for 2011

 

 

4 January 2011. A US economy stuck in neutral, with persistent and growing unemployment.

An on-going financial crisis in Europe.

Everybody knows 2010 has been an economic disaster throughout the “developed” world.

But as traders like to point out, there are always ways to make money —

even if the global situation is full of gloom.

And as fewer of those same traders are willing to admit, even more importantly,

there’s often very little relation between what goes on in the markets, equity and otherwise,

and the “real economy”, in which they are supposedly rooted.

So despite all the negatives — and a few surprises, like the terrifying “flash crash” of the stock market in May, which STILL hasn’t been explained —

2010 proved in the end to be a pretty good year for at least SOME investors —

especially if those owning shares in some high-flying tech stocks, old-fashioned industrials, or gold.

The typical equity fund in the United States returned nearly 19 percent in 2010,

while the Standard and Poor’s 500-stock index rose 12.8 percent.

That was below the gains of 2009, when the markets rebounded from the financial crisis and the S.&P. index soared 23 percent.

Few expected such robust results for 2010 when the year began, said Tobias M. Levkovich, chief United States equity strategist at Citigroup.

So why did stocks do well this year when so much is clearly going wrong?

Perhaps the most important factor was the pro-corporate policies of the Obama administration,

notably, the Federal Reserve’s decision in early November to pump $600 billion into the economy by buying Treasury assets,

along with continuation of the pro-corporate / pro-wealthy individual tax cuts passed by the lame-duck Congress in December,

which together helped propel a year-end rally, lifting the benchmark S.&P. index by about 6.5 percent in December alone.

The overall result was a predictable rise in corporate earnings,

helped along, of course, by rampant slashing in work forces throughout the year,

a convergence that, not surprisingly, was reflected in broad market gains.

But in what is likely to be a worry for next year,

profits were bolstered by job cuts and other restructuring efforts AND NOT revenue growth.

In the third quarter of the year, for example, earnings were 31 percent higher than last year, but revenue increased by just 8 percent.

The disparity was even greater in the first quarter, as earnings jumped 58 percent but revenue rose only 11 percent.

With only so much room to cut costs — after all, how many times can you fire the same workers ??? —

that kind of performance will be difficult to repeat, boding ill for stocks this year.

Not surprisingly, analysts expect profits to increase by 13.4 percent in 2011,

far lower than the estimated 37.8 percent gain for 2010, according to Thomson Reuters.

To make matters worse, Wall Street is brimming with optimism,

which, in the looking-glass world of investing, can actually be a signal to sell.

“The good news has been priced in, and the potential negatives have been ignored,”

said Jason Hsu, chief investment officer of Research Affiliates, a money manager in Newport Beach, Calif., that oversees $70 billion in assets.

“The market is going to get more nervous at these valuations.”

In this context, the Dow Jones industrial average finished with an 11 percent gain in 2010.

The Standard & Poor’s 500-stock index was less than a point lower, at 1,257.64.

The Nasdaq lost 10.11 points, or 0.38 percent, to finish at 2,652.87.

While stocks performed well over all, a small group of listings played an outsize role.

Within the S.&P. 500, Mr. Levkovich said, the top 50 performing stocks contributed about 60 percent of the jump in the index.

Technology was again a star, paced by Netflix, up 219 percent, making it the single best performer in the index.

F5 Networks, which makes equipment to manage Internet traffic, was No. 2, rising about 146 percent.

Cummins, the engine maker, took third place with a 140 percent gain.

Automakers also did well, with Ford rising about 68 percent,

even as General Motors returned to the stock market in a $23 billion initial public offering, the biggest in United States history.

But many individual investors missed the party, having taken their money out of stocks.

They were scared off, it seems, because of the volatility that followed the brief 1,000-point drop on May 6, the so-called flash crash,

as well as lingering concerns from the financial crisis of 2008, including a housing and unemployment hangover.

“Investors in general tend to have a reduced tolerance for risk,” said Brian Reid, chief economist of the Investment Company Institute.

The institute estimates that investors withdrew $80 billion from domestic equity mutual funds in 2010,

while they added more than $250 billion to bond funds.

To be sure, investors still have roughly $4 trillion in domestic stock funds,

but that flight from the market is reflected in other figures, like shrinking trading volume.

Total volume was down 16 percent from 2009, and was 24 percent below the levels of 2008,

according to Howard Silverblatt, a senior index analyst with Standard and Poor’s.

That ate into the results of major banks and brokerage firms, like Morgan Stanley and Charles Schwab, which rely on trading commissions.

The government bond market was precarious as well.

Typically, bond prices go up and yields drop when economic growth is anemic,

reversing course when economic activity picks up and the threat of inflation reawakens.

Indeed, as it became clear the economy was sputtering in the spring and the European debt crisis worsened,

investors began pouring money into bonds, eventually sending yields to all-time lows by early October.

The yield on the two-year government bond, for example, fell below 0.4 percent in early October, a record low.

But with the announcement of the Federal Reserve’s aggressive asset-purchase program,

and the extension of Bush-era tax cuts that were due to expire,

bonds began to sell off in November and December even as stocks rallied, sending yields higher.

James Caron, head of global interest rate and currency strategy at Morgan Stanley, said

2010 was a year of reversals in the bond market.

He added, “You had a 180-degree shift from gloom and doom to optimism.”

For the year, the typical bond fund returned 5.6 percent, according to Morningstar.

Bonds may be a traditional refuge in turbulent markets, but it was gold that really shined.

Like bonds, gold benefited from a flight to safety spurred by the European debt crisis.

But it also raced higher on fears that budget deficits in Western countries, including the United States, are unsustainable

and that lax monetary policies would weaken the value of paper currencies over time.

The returns of typical gold mutual fund, including mining companies and a range of precious metals, moved higher by 40 percent.

Crude oil, another closely watched commodity —

albeit one with actual USE-VALUE, unlike the purely speculative gold —

rose from $79.86 a barrel to $91.38 a barrel, less than 15 percent,

after rising 78 percent in 2009, according to this article in the New York Times.

Anyone who pretends to know what’s going to happen in ANY of these markets, of course,

is kidding themselves, not to mention anyone foolish to heedlessly follow their words.

But even the most summary analysis of what happened in 2010

should give pause to anyone who actually believes “happy days are here again.”

They clearly are not.

David Caploe PhD

Editor-in-Chief

EconomyWatch.com

President / acalaha.com