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Past Was Not Prologue
The amazing reversal of U.S. and global stock markets was the financial story for 2009. After a disastrous 2008, world financial institutions seemed to be on the brink of collapse early last year, and investor panic set in. Stock indices plunged about 25% in just 10 weeks. Then in early March, defying all investor expectations, stock markets around the world started moving upward – and never looked back. The past year is another example of why investors must apply discipline to portfolio management. Succumbing to immediate emotional impulses can be a costly error. In this case, investors who sold stocks in a panic last March lost considerable money when they missed the stock rally that subsequently occurred.
Many international stock markets continued to trounce U.S. stocks in 2009. Some emerging market stock indices such as Argentina and China gained more than 100% for the year. Note that stock markets of developing countries are extremely volatile and carry considerable risk. The opportunity for enormous investment gain carries along with it the chance of enormous loss.
The most recent stock rally is encouraging. Yet even after the large gains this year, the S&P 500 still remains about 25% below its peak in late 2007. Looking back a bit further, the S&P 500 is also about 25% lower than its level in December 1999 – ten years ago! The past decade has not been profitable for stock investors.
Diverse Economic Forecasts
Economists remain divided about the U.S. economic outlook. Here are some key data points we are tracking:
Growth U.S. economic growth appears to be slowly accelerating entering 2010. Most economists expect U.S. GDP growth to range from 2.5% to 4% for all of 2010 – well below the 6% post-recession historical figure. Cyclical sectors such as autos, houses and capital equipment spending, combined with continued monetary and fiscal stimulus, will help 2010 growth.
Employment Following brutal job losses in 2009, signs point to job gains in 2010. However, the unemployment rate may spike higher in early 2010, as workers who had been too discouraged to look for a job start searching again. History suggests it could take up to five years of expansion to push the unemployment rate back down to a "full employment" level of 5%.
Profits Earnings are rising rapidly following a historic plunge in late 2008. A sustained economic expansion, characterized by low wage growth and low interest rates appears to be the most likely scenario. This would help profits continue to rise.
Inflation Despite rising energy prices over the course of 2009, measures of core inflation remain subdued. With the considerable slack in U.S. and global economies, there does not appear to be much real risk of consumer price inflation. In fact, the more likely risk is one of deflation, if there is an economic relapse. Excess liquidity may lead to asset bubbles in certain markets however.
Interest Rates The Federal Reserve appears convinced the inflation threat is low and is committed to fostering a recovery both in the economy and financial markets. This should result in a very low federal funds rate throughout 2010. Long-term rates may rise, however, reflecting a stronger economy, rising government debt and a gradual removal of the Fed's quantitative easing measures.
Portfolio Strategy
CPIC is cautiously optimistic about the improving economic environment, and portfolio choices reflect that view. Over the past several months, we increased equity portfolio weightings from early 2009. We expect to add to the equity allocation, increasing international exposure along the way. Certain bond sectors may offer stock-like returns this year as they did last year. We will keep a healthy allocation in both U.S. and global fixed income, since these sectors offer the double benefit of lowering portfolio risk and possible attractive returns. With bank money markets paying close to 0%, now is a good time to let CPIC help you put “spare cash” to work. Happy New Year! |
