Grim Investment Picture for 2011

4 January 2011. A US economy stuck in neutral, with persistent and growing unemployment.

An on-going financial crisis in Europe.

Everybody knows 2010 has been a fiscal disaster throughout the "developed" world.

But because traders like to point out, there will always be ways to make money —

even if the global situation is filled with gloom.

And as fewer of those exact same traders are willing to admit, even more importantly,

there’s often very little connection between what goes on in the marketplaces, equity and otherwise,

and also the "real economy", in which they are allegedly rooted.

So despite all the negatives — and a few surprises, like the actual terrifying “flash crash” of the stock market in May, which STILL hasn’t been explained —

2010 proved in the end to be a pretty good year not less than SOME investors —

especially if those possessing shares in some high-flying tech shares, old-fashioned industrials, or gold.

The typical equity fund in the United States returned nearly 19 percent in 2010,

while the conventional and Poor’s 500-stock index flower 12.8 percent.

That had been below the gains of 2009, when the markets rebounded from the economic crisis and the S.&P. index soared 23 percent.

Few expected such robust results for 2010 when the year began, stated Tobias M. Levkovich, chief United States collateral strategist at Citigroup.

So why did stocks do well this year when so much is clearly going wrong?

Perhaps the most important factor was the pro-corporate guidelines of the Obama administration,

notably, the Federal Reserve’s decision in early November to function $600 billion into the economy by purchasing Treasury assets,

along with continuation of the pro-corporate / pro-wealthy individual tax slashes passed by the lame-duck Congress in December,

which together helped launch a year-end rally, lifting the actual benchmark S.&P. catalog by about 6.Five percent in December alone.

The general result was a predictable increase in corporate earnings,

helped along, obviously, by rampant slashing in work forces throughout the year,

a convergence that, not surprisingly, was mirrored in broad market increases.

But in what is likely to be a worry with regard to next year,

profits were bolstered by job cuts and other restructuring efforts AND NOT revenue growth.

In the third quarter of the year, for instance, earnings were 31 % higher than last year, but revenue increased by just 8 percent.

The disparity was even greater in the first 1 / 4, as earnings jumped Fifty eight percent but revenue rose only 11 percent.

With just so much room to cut expenses — after all, how many times can you fireplace the same workers ??? —

that kind of overall performance will be difficult to repeat, boding sick for stocks this year.

Not surprisingly, analysts expect profits to increase by 13.4 percent this year,

far lower than the estimated Thirty seven.8 percent gain for 2010, according to Thomson Reuters.

To make matters worse, Wall Street is brimming with optimism,

which, within the looking-glass world of investing, can actually be considered a signal to sell.

“The good news continues to be priced in, and the potential negatives have been ignored,”

said Jerr Hsu, chief investment officer of Research Affiliates, a money manager in Newport Beach, Calif., which oversees $70 billion in assets.

“The market is going to get more nervous at these valuations.”

In this context, the Dow Johnson industrial average finished with a good 11 percent gain in 2010.

The Standard & Poor’s 500-stock index had been less than a point lower, at 1,257.64.

The Nasdaq misplaced 10.11 points, or 0.38 percent, to finish at 2,652.87.

While stocks performed well over all, a small group of listings played a good outsize role.

Within the S.&P. 500, Mr. Levkovich said, the very best 50 performing stocks added about 60 percent of the jump in the index.

Technology was again a star, paced through Netflix, up 219 percent, which makes it the single best performer in the index.

F5 Networks, which makes equipment to manage Internet traffic, wasn’t any. 2, rising about 146 %.

Cummins, the engine maker, took third place with a 140 percent gain.

Automakers also do well, with Ford rising about 68 percent,

even because General Motors returned to the stock exchange in a $23 billion initial public offering, the biggest in United States history.

But numerous individual investors missed the party, having taken their cash out of stocks.

They were frightened off, it seems, because of the unpredictability that followed the brief 1,000-point drop on May 6, the so-called flash crash,

as along with lingering concerns from the financial crisis of 2008, including a real estate and unemployment hangover.

“Investors generally tend to have a reduced tolerance with regard to risk,” said Brian Reid, chief economist of the Investment Company Institute.

The institute estimates that investors withdrew $80 billion from domestic equity mutual funds in 2010,

while they added more than $250 billion to bond funds.

To be sure, investors still have roughly $4 trillion in domestic inventory funds,

but that flight in the market is reflected in additional figures, like shrinking buying and selling volume.

Total volume was down 16 percent from 2009, and was 24 percent below the levels of 2008,

according to Howard Silverblatt, a senior index analyst with Standard and Poor’utes.

That ate into the results of major banks and brokerage companies, like Morgan Stanley and Charles Schwab, which depend on trading commissions.

The government bond market was precarious as well.

Typically, bond prices go up and yields drop when financial growth is anemic,

reversing course when economic activity picks up and the threat of inflation reawakens.

Indeed, as it became clear the economy was sputtering early in the year and the European debt turmoil worsened,

investors began pouring money into bonds, eventually delivering yields to all-time lows through early October.

The yield around the two-year government bond, for example, dropped below 0.4 percent in early October, a record low.

But with the announcement of the Federal Reserve’s aggressive asset-purchase program,

and the extension of Bush-era tax cuts that were due to expire,

bonds began to sell off in November and Dec even as stocks rallied, sending produces higher.

James Caron, head of global interest rate and currency strategy at Morgan Stanley, said

2010 was a year of reversals in the bond market.

He added, “You had a 180-degree shift from gloom as well as doom to optimism.”

For the year, the typical bond fund came back 5.6 percent, according to Morningstar.

Bonds can be a traditional refuge in violent markets, but it was precious metal that really shined.

Like bonds, gold benefited from a flight to safety sparked by the European debt crisis.

But it also raced higher on fears that budget loss in Western countries, including the United States, are unsustainable

and that lax monetary policies might weaken the value of paper foreign currencies over time.

The returns of typical gold mutual fund, including mining companies and a selection of precious metals, moved higher by 40 percent.

Crude oil, another closely watched commodity —

albeit one with real USE-VALUE, unlike the purely speculative gold —

rose from $79.86 a barrel to $91.38 the barrel, less than 15 percent,

after rising 78 percent in 2009, according for this article in the New York Times.

Anyone that pretends to know what’s going to happen in ANY of these markets, of course,

is kidding themselves, not to mention anyone foolish in order to heedlessly follow their words.

But the most summary analysis of the items happened in 2010

should provide pause to anyone who really believes "happy days tend to be here again."

They clearly are not.

David Caploe PhD

Editor-in-Chief

EconomyWatch.com

President / acalaha.com