Investor’s 2010 Two-Step: Hold On To ’09 Gains – Build on Them in ’10

Did you make money in 2009? Hats off if you had a sound investment plan heading into the year and stuck to it…no easy feat! Odds are you were handsomely rewarded as world markets staged a robust if somewhat improbable rally. Amid unprecedented levels of skepticism & pessimism in the spring, equity and fixed income markets embarked on a strong upward move that carried all the way through year-end.

The Information Technology Sector (+59.9%) pushed the tech-heavy Nasdaq Composite Index to a +43.9% annual gain. The small-cap Russell 2000 Index advanced +25.2% followed by the large-cap S&P 500 Index and Dow Jones Industrial Average, up +23.5% and +18.8%, respectively.

Investors fleeing the perceived safety of U.S. Treasury Bonds created a “once in a lifetime opportunity,” according to the Wall Street Journal, for fixed-income returns of +50% or more in riskier investment-grade corporates (+20%) and high-yield (i.e., junk) corporates (+59%). Those left holding U.S. Treasuries suffered as prices fell -9.3% (10 yr. total return index).

Economically sensitive categories like basic materials (+45%), particularly commodities, rallied with base metals (e.g., copper (+139%), zinc (+125%), palladium (+117%)) outperforming precious metals (e.g., silver (+49%), gold (+24%)).

Our advice to investors in December ’08 was that government policy would be the single biggest determinant of economic activity in 2009 and cautioned not to “underestimate the power of the unprecedented economic stimulus being injected into the global financial system.” Moreover, we felt that “the cumulative effect of these actions will begin to gain traction in 2009 and the stock market, as a forward-looking discounting mechanism, will rally on anticipation of better economic times ahead. Likewise in the credit markets, bond prices will rise as the risk of credit defaults show signs of diminishing and more normal financing activity resumes.” No forecast of future events can be completely accurate, including ours, but the major themes we envisioned for 2009 fell into place.

As welcome as the rebound of 2009 was, we are abundantly aware that the market value of many investors’ portfolios remains below their all-time high. The recent gains, therefore, represent a recouping of prior losses rather than the creation of new wealth, and investors may find their enthusiasm tempered accordingly. As professional money managers, we couldn’t be more sensitive to this and, as a result, it is uppermost in our minds as we plan individual portfolio strategies for 2010.

The Game Plan for 2010

Government stimulus & intervention drove the markets in 2009. As the economy slowly strengthens, the reduction of government stimulus will be a major factor impacting both the rate of growth and the direction of capital asset prices. Federal Reserve interest rate policy is central to achieving steady, non-inflationary growth sufficient to create jobs and reduce unemployment. That, in turn, will impact consumer confidence and spending, the latter accounting for two-thirds of all U.S. economic activity. If interest rates rise in 2010 and inflation remains tame, the value of the U.S. dollar will strengthen vs. foreign currencies. That would put downward pressure on the price of oil & oil derivatives as well as gold and other precious metals.

History is littered with examples of instances when the Federal Reserve’s interest rate policy was either too restrictive or too accommodating. Economics, after all, isn’t considered by many to be one of the “soft sciences” for nothing. An earlier-than-expected or larger-than-expected increase in interest rates could send the markets into a tailspin that would effectively give back a chunk of 2009’s investment returns. Therefore, the watchword for 2010 is CAUTION. Aim to hang-on to what you gained in ’09 and build on it. Don’t swing for the fences just in case the Fed gets it wrong.

In the context of the macroeconomic backdrop above, incorporate the fact that the highest-returning investments in 2009 tended to be riskier, low quality names that were pummeled in 2008. Those have had their run on a relative basis so investing in last year’s winners could very possibly be a losing strategy. Rather, a loosely predictable market rotation is likely to occur whereby the early recovery cycle winners yield to mid- and late-stage recovery candidates. For example, Information Technology (+60%), Basic Materials (+45%), and Consumer Discretionary (+39%) stocks led the market in 2009 and, if we are correct, are unlikely to repeat as leaders in 2010. We look for the Financial, Health Care and Energy sectors to outperform on a relative basis in the coming months. Also, selected sub-sectors like Wireless Internet infrastructure & services present attractive growth opportunities, in our opinion.

What investment ideas or strategies do you have for 2010?

The opinions expressed here are those of the author and are not in any way a recommendation to buy/sell any specific investment security. You should do your own research and consider seeking professional investment advice specific to your individual situation before acting on any information contained on this website.