4th Quarter 2009 Review

From the Desk of Ron Rowland

The year 2009 is now in the history books. For most benchmarks it was a good year, but I haven't seen much celebration. Why? I think many people are still spooked by the chaos of 2008. I also believe it is a mistake to discuss 2009 separately from 2008. Only when viewing the two years combined can you begin to understand the results.

Examples have been apparent since the calendar rolled over. As usual, major financial publications featured lists of the "best performers" of the past year. Topping those lists this time around was Russia, with the Market Vectors Russia ETF (RSX) gaining +139% in 2009. Most did not mention that for the past two years the same Russia fund was down -37%. Even after a +139% gain, investors who bought two years ago are still holding significant losses.

"I would never have bought Russia," you might say. "I'm not a speculator." Fair enough. Maybe you decided to diversify your assets and bought an S&P 500 index fund. The one-year result for S&P 500 in 2009 was about +26%. The two-year cumulative return drops to -20% when you include 2008.

You also need to look at other measurements besides the two-year returns to understand the risk involved. One such measure is drawdown – or how big the decline was at its worst point. The recent drawdown was more than -55% for the S&P 500, and nearly -82% for the Russia ETF.

I'm not cherry picking results here. You can find comparable examples almost everywhere. Even a relatively conservative investor who bought SPDR S&P Utilities (XLU) lost -20% in the last two years. Many "target-date" mutual funds had equally dismal results.

One-year returns are not particularly meaningful in a statistical sense – and calendar years even less so – but investors still fixate on them. The temptation to buy last year's winners and/or sell last year's losers can be overwhelming. Of course, long-term numbers can also be misleading. For instance, if you buy a mutual fund because its ten-year average is +8%, what will be your return after the first year? It might be much more than +8%, it might be much less, but it will almost certainly be different from the long-term average.

Diversification is a good risk management tool but does not adequately address market risk. At CCAM we diversify using stock, bond, and commodity funds to try to reduce individual security, sector, and asset class risks. But we take it one step further and also attempt to reduce market risk.

The Quarter in Review

The last quarter of 2009 capped a turbulent year in almost every sector of every market around the globe. At one point in early March the financial system looked like it was on the edge of a breakdown, but a remarkable reversal turned the calendar year into a success for those who held on for the entire period.

On the other hand, the fourth quarter's gains were less impressive, and some sectors had outright losses. The Federal Reserve remained one of the top factors. It was the Fed's announcement back in March that it would be buying massive amounts of government and private debt that sparked the huge rally. Then as the year wound down and the end of monetary stimulus seemed to be in sight, the liquidity-driven boom began to subside.

For the year, the S&P 500 including dividends posted a gain of +26.5%, and +6.0% in the last quarter. Technology was the leader in both periods. Here is a breakdown of U.S. equity markets by sector, using the Select Sector SPDR ETFs as examples.

Technology was joined at the top of 2009's leaderboard by Materials and Consumer Discretionary, but since both of these sectors have much smaller market capitalization, the technology outperformance was the big story of 2009. This is why the tech-heavy Nasdaq Composite Index gained +43.9%, handily outpacing the broader S&P 500.

Much of the recent action, both in the U.S. and internationally, has been driven by currency values. The U.S. Dollar weakened considerably against most currencies in 2009. Long-term interest rates rose sharply. The ten-year Treasury yield began the year at 2.24% and ended at 3.84%. This is still low by historic standards, but the change in 2009 was remarkable.

Gold performed well all year but really took off in October when bullion prices moved above the $1,000 mark and stayed there the rest of the year. Other commodities, notably copper and crude oil, also had banner years. Of course, this came on the heels of a collapse in most of those same commodities in 2008. In most cases (gold being the exception), they are still well below their all-time highs. How much of the commodity rally was due to the weak dollar vs. fundamental supply/demand factors is a subject of debate.

As the year ended, most market segments were still strong. Sector leadership was still concentrated in Technology, along with Materials. Financials, Consumer Staples and Energy were lagging. A correction began to unfold in China, suggesting that maybe Asia is not so impervious to global economic weakness after all.

What is coming in 2010? As noted above, much still depends on fiscal and monetary policies that are politically-driven and therefore hard to predict. The key question is whether the governmental stimulus will continue, or whether it will be withdrawn. If the latter, the question is how it happens. We continue to remain flexible and follow the trends as we see them.