Pessimism was not the winning bet in 2010

All year long, a distinguished parade of experts soberly explained to investors why stocks were too risky.  Bugaboos included:

·         The Eurozone crisis in Greece

·         The Eurozone crisis in Ireland

·         The surging US deficit

·         Projected "collapse" of the US municipal bond market

·         Risk of "double dip" recession in the US

·         Quantitative easing by the Federal Reserve

·         Still stagnant real estate market and the tsunami of foreclosures

·         US unemployment stubbornly stuck over 9.6%

·         Rise of China as a world power

·         High gold prices signaling inflation and social unrest

·         Etc.

Even so, by November 30th, US stocks gained 7.9%, in line with our 2010 forecast of 8%.  Over the next 20 trading days, US stocks gained another 6.9%, nearly doubling the YTD gain to 15.3%.  How can this be, given all the negatives above?  Stock prices discount the future, not the past.  US corporations are lean, mean, flush with cash, highly profitable and earning ever more revenues from international operations.  Stock valuations remain at the low end of historical ranges, particularly given the low interest rate environment.  When the market offers you good companies on discount, buy!  If you wait until all the negatives are addressed (and let's face it, there are always negatives,) the sale is usually over.

How to explain the rally of the last month?  Hate to say it but the investors who jumped out of stocks at the March 2009 low of 676.53 on the S&P 500 started jumping back in once 1200 solidified as the current market floor.  Well fine, but those investors failed to realize gains of at 75-85% over the last year and a half.  An investor who bought the S&P 500 the day Lehman filed for bankruptcy September 15, 2008 is down 4.3% net of dividends.  The Barclays (formerly Lehman) Aggregate Bond Index is up 8.5% over the same time frame.  An investor with a portfolio of 70% S&P 500, 30% Lehman Aggregate index is down 0.5% through "the worst financial crisis since the Great Depression" if that investor stayed fully invested.   Note that these returns are unlevered.  Levered investors mostly experienced far worse returns because margin calls stopped them out at market lows. 

Read the entire commentary here.