January 4th, 2010 12:07 PM by Mel Samick
Summing up the paradox that was 2009, someone recently asked me the question, "How can the stock market be going up when so many people are losing their jobs?" The short answer is that stock market participants don't drive by looking in the rear-view mirror or even the side-view mirror of current events. Market levels today are driven by expectations about where the economy, corporate profits, and interest rates are going to be in the future. And right now, the stock market and other risk-asset markets are looking ahead to a pretty decent recovery.
Last year was a roller-coaster ride that went well beyond the regular roller-coaster ride that is the norm in the financial markets. We opened the year with the world looking at the prospect of a major "Armageddon." Lehman Brothers, a firm that many on the Street had regarded as "Too Big to Fail", had just been declared bankrupt. Important sectors of the financial markets were still effectively frozen, and policy-makers were working desperately to restore confidence and bring the markets and the economy back from the brink. In this panic environment, risky assets were already priced at deeply distressed levels, and they continued to deteriorate all the way through March. The only assets anyone wanted to own were Treasury Securities and cash "under the mattress." Treasuries were the only asset providing any genuine diversification to offset losses in virtually every other market. The happy ending to this story is that the markets did resume functioning and the economy did begin showing signs of life and growth as the year progressed.
After the roller-coaster ride was over, the S&P 500 (representing the largest companies) posted a very nice total return of nearly 27 percent for the year, while smaller-company stocks and more growth-oriented companies delivered returns in the 35-40 percent range. Foreign stocks in developed markets likewise posted returns of about 37 percent in dollar terms. Stocks in emerging markets were the biggest winners, with overall returns in the 75-80 percent range, with Russia leading the pack with a whopping 128 percent return for the year. U.S. real estate investment trusts, which were beaten up so badly in the real estate crisis, rebounded smartly with a 30 percent gain. Rounding out the risk-asset category, high yield bonds (a.k.a. "junk bonds") delivered very strong returns in the 50-60 percent range, depending on the level of "junkiness." Basically, the riskier the asset, the more severely it was depressed at the end of 2008, and the more strongly it rallied when the panic eased.
Near the other end of the risk spectrum, diversified bond portfolios posted hum-drum returns in the 4-7 percent range, depending on maturity and asset mix. Treasury notes and bonds fell as their panic-induced price premiums from late 2008 began melting away. Long-term Treasuries were down more than 12 percent for 2009, even after taking into account reinvested interest. Shorter-term Treasuries also fell in price, but to a lesser degree. Investors who kept their money in safe, short-term assets like Treasury Bills and money market funds earned returns in the 0 percent to 0.5 percent range, as Federal Reserve policy was deliberately engineered to keep short-term rates low and give "Chicken Little" investors a kick in the pants to get them back out onto the risk spectrum. Watching your money collect dust at 0.25 percent provides just that incentive.
Now that the economy has taken a few steps down the recovery path, policy makers face the challenge of how to gently disengage their arsenal of economic stimulus without sending the markets and the economy back into a tailspin.
For this week, there are quite a number of economic releases on the calendar. The biggest will be the employment report on Friday. The expectation is for the jobs number to be flat (approximately the same number of jobs created as lost in December), and although that may sound bad, if it comes to pass it will be the first time in two years without a negative reading. The unemployment rate is expected to tick up to 10.1 percent. It may seem counter-intuitive for the unemployment rate to rise if the job count doesn't shrink, but remember that there is natural growth in the workforce population. So there's a pretty significant hurdle of job creation that has to be met just to absorb the additional workers.
Thanks for your business. Have a great week and a very profitable 2010!
Information provided by Amtrust Bank Capital Markets