2010 Leaves the Same Way It Started; Consensus Changes for 2011

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 |  Includes: DIA, QQQ, SPY
by: Yale Bock

2010 was a solid year for general stock index performance in the United States as all of the broader equity indexes finished ahead by at least 10% over 2009 year-ending levels. In retrospect, the deep mistrust of the stock market, especially after 2008, has helped fuel the transition of capital into the fixed income markets. Bond markets have enjoyed a 10 year bull market with 2010 seeing the 30 year U.S. Treasury yield falling to below 4%. Billions of dollars have left equities because of the lack of performance for the decade from 1998-2008. With the flight of capital speaking very loudly, people did not trust the 30% stock market rally in 2009.

As a result, the first 4 months of 2010 saw 15% gains in equities as investors watched the market climb a "wall of worry." In April of 2010, a BP (NYSE:BP) oil well blew up in the Atlantic Ocean, the European debt crisis began in full force, and skittish investors again worried stocks were too risky to own. From April to August of this year, stocks retreated about 30% from peak to trough, and yet again, people said, "Enough of this, I'm outta here."

Naturally, September of 2010 saw sentiment shift again and the stock market rebounded 15% in a month, and rallied through the end of this year. How things can change, and always do, in capital markets! In looking at the financial world analytically, one must view alternative choices to stocks to see how attractive stocks are on a relative basis. Even today, bond prices are still way up as bond yields hover around record lows. Commodities have had a nice run in many different areas, especially in coffee, gold, and silver. With an overhang of oversupply in the residential real estate space, private equity deals still on investment banks balance sheets and money market funds yielding next to nothing, stocks look pretty attractive on a relative basis. As such, economists from the majority of investment banks on Wall Street, including Goldman Sachs (NYSE:GS), are now predicting a 10-12% rise in the stock market for 2011. Oh boy, the little voice in the back of my thinks, 'It's really time to be careful if these guys think all is clear.'

When one looks at the current market psychology of many participants, these bullish forecasts lead me to believe the first few months of 2011 will be very unpredictable. I note that you have guys like Doug Kass predicting a flat market for 2011, with gold cratering to $250/ounce. Another noteworthy investor is John Paulson from "The Greatest Trade Ever" book fame, who believes gold will go to $4000/ounce by 2012. You have to love the range of opinions from prognosticators in the capital markets. My opinion is the U.S. faces its challenges, like large fiscal deficits, a sky high bond market which needs to be pricked, languishing unemployment, the lingering housing oversupply issues, political dysfunction in Washington, and the debt and deficit issues at all levels of government: local, state, and federal.

However, relative to the rest of the world, the U.S. does not look that bad. Europe struggles with sovereign debt issues which have resulted in huge refinancing in Greece and Ireland, and debt downgrades in Portugal, with Spain and France possibly on the way. South America is laden with so called socialist dictators and incredibly high inflation rates, along with countries where one wonders what the rule of law means at any level. The BRIC countries have GDP growth rates which are quicker than mature countries, but corruption, transparency, lack of infrastructure, a dearth of intellectual property innovation, mounting inflation worries, and relatively low wealth levels make investment in these countries not exactly risk free.

So, all in all, with U.S. corporations enjoying record profit levels, cash rich balance sheets, a high unemployment rate to moderate wage level inflation, low official inflation (if it can be believed), and low interest rates, investing in stocks looks pretty good to me. However, one thing I know is the only constant is change and the unexpected, so I am wary about the optimism over a good 2011. Still, doing one's homework and trying to use pessimism as your friend leads me to like equities over anything else, but then again, I usually do.

Global Economic & Financial Markets Outlook: 2010 BRIC Peformance and Year End Winners and Losers

(All country index data provided by the market data section of the Wall St Journal December 30, 2010)

2010 was a year where dramatic outperformance and lack of performance occurred all across the globe, which is probably what should be considered "normal", if there is such a thing as normal in the investment business. As opposed to 2008 where almost every market went down, and 2009, when nearly every global market went up, there are dramatic differences with investment results when looking at specific countries, and to a certain extent, global areas. The most obvious result would be the lack of performance in Europe, which investment watchers know has to do with the sovereign debt issues of the member countries. Conversely, many of the big winners are located in Asia, with some countries posting very impressive results. First, let's look at the performance of the BRIC countries.

The best phrase to sum up the investment results of the indexes composing BRIC countries would be "a mixed bag." The obvious winner for 2010 would be Russia, up 24%, and India, ahead by 16.7%. Those indexes are the RTS Index of Russia and the Bombay Sensex Index of India. The poor performers were the Dow Jones China 88 Index of China, down 20.6% and Brazil Index (Sao Paulo Bovespa), which lagged at +1.0% for the year.

In looking for great performance, there were many notable indexes which performed incredibly well. Sri Lanka (Colombo Stock Exchange), posted an incredible 95.4% return, followed by Argentina (Merval), with a 51.4% advance. Other exceptional index performers are Indonesia (Jakarta Composite) +46.1%, Thailand (SET) +40.6%, Phillipines (Manila Composite) +37.6%, Denmark (Copenhagen OMX) +35.3%, Chile (Santiago IPSA) +37.6%, Pakistan +28%, and Poland (WIG) +19.3%.

On the other end of the equation, the biggest losses occurred in Europe with Greece down 47.2%, Spain losing 17.4% (IBEX 35), Italy reversed 13.2% (FTSE MIB), Portugal a -9.6% (PSI 20), and France (CAC 40) falling 2.2%. Poor performers also include China (-20.4%), and Japan (Nikkei) down 3.0%. Interesting about the global indexes is many people see the foreign markets as having more risk, some of which is currency related. I know currencies can be hedged, and in light of that fact, I certainly think China and Brazil are worth more research as growth there should be better than in mature areas like North America and Europe (I know, I am really going out on a limb there).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.