2010: The Year of Reflation

Includes: AGG, CRB, OIL, SPY
by: The Housing Time Bomb

Since it looks like the holiday trade is on, I thought I would look back and see how various sectors performed in 2010:

(Click to enlarge)

My Take:

If you were an inflationist you did pretty darn well last year. Commodities were clearly the play of the year. I find it kinda funny to look at the S&P 500 performance relative to other investment options.

CNBC would love to make you believe that buying stocks was and always is the best thing to do. As you can see above, this was clearly not the case in 2010. Ironically, bonds gave a lot back since November when the Fed started it's brilliant QE strategy.

You can thank the Fed's reckless policies (along with lots of Chindians) for the commodity run. The dollar has held up well as of late as a result of the European debt fiasco but it's clearly evident above that the market believes inflation is coming.

If you were a deflationist in 2010 you pretty much got slaughtered. The classic deflation trade is to go short stocks and energy and go long the dollar and bonds. So much for that idea in 2010.

Personally, I was pleased with my year for the most part. I did well with gold and silver. My bond funds did well thanks to PIMCO. I lost a little on some short hedges but I was glad I owned them when we dipped this summer. My cash didn't do anything thanks to low rates. In fact, I probably lost money from an inflation adjusted standpoint but that's OK. The security of knowing it's there is invaluable from my perspective at this point in the game.

Where Do We Go From Here?

This is the million dollar question. I will touch on this today but stay tuned for a THTB Top 10 prediction list for 2011. I see this done a lot and i liked it, so I figured I would give it a shot.

I think a lot of what happens in 2010 will come down to the Fed, the bond market, and politics. I think Obama put himself in a bad spot by passing the tax cuts. I say this because Washington DC is going to change drastically starting next year. The House and the Senate will both be filled with several new tea partying Republicans who are going to want to cut spending. As the deficit worsens we will see increasing pressure to do something to stop it.

This is going to lead to job cuts and other austerity measures beginning in 2011. I don't expect anything drastic but it will start nonetheless. Obama is going to end up looking bad when the Republicans start cutting because the middle class are the ones who are going to feel the pain. Obama will then get painted the President who gave the middle class the shaft after giving tax cuts to the rich. This will be a political nightmare for him down the line and ironically I think the left may hate on him on this issue as much as the right does.

The Bottom Line

We have clearly reached a fork in the road when it comes to the markets and the economy. Unemployment remains high and is getting worse. Our deficit is on the verge of not being manageable as bond yields continue to rise.

Stocks have priced in a strong 2011 recovery which I don't think is going to happen. I can't see any material recovery without a nice uptick in jobs. The only reason we had a recovery this year was because the government was willing to put it on it's credit card. The economy would have been miserable this year without their handouts.

The Fed would love to rinse and repeat the same thing this year which is why we got QE2. The problem with this idea is the Fed now has the bond market to deal with. They aren't too keen on this idea. They are becoming increasingly worried about our deficits because they see no recovery that can pull us out of this mess.

The Fed doesn't see the recovery either. If they did then they would have never pushed the QE2 button. Bernanke knows this can't work but he did it anyway because there was no other option. The after shocks are still being felt from our "printing" announcement. Bonds have collapsed and commodities have soared ever since.

This is going to be felt down the line by stocks as increased costs hurt margins. Remember: Oil remains stubbornly high and you need oil to make pretty much everything in our economy. The bottom line is, I expect lower stock prices in our future as the market realizes that the great 2011 recovery was nothing but a pipedream.

Disclosure: No positions