It's 2010, The Year Of The Alphabet

The year 2009 is now in the history books and it certainly was quite a year. To look at the final year end performance statistics one would certainly say that it was a banner year for the investment markets. The Dow Jones Industrial Average was up 18.8%, the Nasdaq up 43.9%, and the S&P 500 a positive 23.5%. Let's take a minute though and flash back one year. The economy and markets were caught up in an incredible financial meltdown and anxiously awaiting the outcome of a Federal Government stimulus being proposed by the new Obama administration. The bottoming, at least from the standpoint of the investment markets, was realized on March 9, 2009.

From that calendar date to the end of the year the markets had an astonishing run to the finish line. It was like the afterburners on one of our space shuttles being lit and just heading off into the atmosphere. During that time the Dow was +59.28%, the Nasdaq +64.83%, and the S&P 500 +64.83%. Remarkable as it was it is important to keep another benchmark in perspective. Using the Dow as an example, in spite of its good performance in 2009 it is still 26.4% down from its all time record high set in October 2007. The investment markets have a lot of work yet to be done along with the economy!

So where are we headed in 2010? Depending on which economic or financial analyst is currently expressing his or her opinion in the media we could be looking at the economy behaving as a letter of the alphabet. If it's an L, that would suggest a straight line down giving up some percentage of the recovery we made and possibly leveling off for an indefinite period. It could be a V, which could imply that we will head down somewhat, maybe a 10-15% pullback, and go straight back up similar to the way the market behaved in 2009. Another scenario offered is a W, which is a double dip that returns us all the way to the original meltdown level before eventually recovering again. Then there is the U. This suggests that there will be some pullback with a protracted bottoming that begins to deliver an economic recovery at a slower pace but eventually guiding the market beyond the thrust achieved in 2009.

So class, the key letters of the alphabet that we need to be familiar with this year are once again L, V, W, and U. We are not making any prediction which letter will dominate the economic landscape. There are too many economic issues still in play which can alter the course of recovery very quickly and require a change in the investment thesis. The bottom line, we just need to stay on top of developments.

So what are some of the facts that we do know? To the extent that we have had any degree of housing recovery to date, it would be attributed to financing provided by the Federal Reserve in the mortgage market by buying more than $1 trillion in mortgage backed securities. That support is scheduled to end in March of this year. Certainly that could be a negative. A positive point would be that the stimulus pool of dollars authorized last year in the amount of $750 billion will essentially begin to be spent this year. The hope certainly is that this will create momentum for job creation.

While our hope is for the investment markets to go up again in 2010, there are other areas of the economic and political landscape that will probably see increases and will have some consequence on that happening. They are taxes, government debt levels, and interest rates. With much of the 2001 Tax Act already in transition or ready to sunset on January 1, 2011 there will be tax revisions made by the administration this year. That is a matter to be watched as it will effect such issues as estate planning, ordinary income tax rates, and capital gain rates. Government debt levels will continue to rise to provide the funding for such things as the stimulus package. There is much concern within the economic community already as to our rapidly increasing debt level.

Then there is the matter of interest rates. There is only one direction that they can go since we are essentially at zero, so that is up. The big question on the agenda is when will the Federal Reserve begin to raise interest rates? They are certainly playing a great poker game at this time by not tipping their hand. The consequence of that, however, is that when the central bank remains quiet it creates much speculation in the investment markets about their plans and hence increases volatility. Admittedly, we recognize that they have a delicate balancing act on their hands with significant risks. If they begin tightening rates too soon it could derail a budding recovery. On the other hand, waiting too long to raise rates could kindle an inflationary firestorm. Clearly the decision on interest rate management will be of utmost consequence to economic recovery.

It will be an interesting year and, by the way, let's not forget watching the healthcare issue play out in Washington. So at this point we will adjourn our class for the time being and remind you to watch those letters of the alphabet. In conclusion, it is also only fitting to wish everyone in order of importance a happy, healthy, and prosperous New Year.