December 2010 – Market Commentary

-US Stocks saw the second straight year of gains in 2010 ending up 15% for the year with the US government continuing to prop up the economy.  The year was not without some major challenges with the European debt crisis, mixed US economic figures, and increasing concerns over the tightening of Chinese monetary policy.  The Flash Crash in May added to investor’s nervousness and investors moved into fixed income and specifically Treasury bonds.  As funds continued to pour into fixed income investments, yields reached record lows and bonds outperformed stocks for the first half of the year.  With worries about potential deflation and the mounting evidence of weak economic growth the Fed jumped in again and brought much needed confidence to the market.  For a more robust recovery an improvement in hiring and the housing market is needed, but optimism is high to start 2011.

Economic News
-Hiring, or the lack there of, was a chief issue holding back the economy throughout the year.  US unemployment remained stubbornly high between 10% and 9.5% all year.  However, there is hope that the job market is improving as jobless claims dropped throughout December.  Unemployment benefit claims fell to their lowest level in 2 years and the number of job postings has surged compared to a year ago.

-The weak housing market has been another thorn in the side of the economy throughout the year.  Prices were mixed and sales rose in the first half of the year due to the new home tax credit, but fell off dramatically afterwards with new home sales hitting lows not seen since the 1960’s.  Mortgage rates have ticked up slightly but remain low and below 2009 levels.

-GDP growth stared off strong in 2010 but then dipped in the second quarter before picking up pace to end the year.  Many financial readings reflected the mixed performance with manufacturing and consumer spending rising in the first quarter falling in the middle of the year and then rising in the second half of the year.  Estimates for 4th quarter GDP have been increasing with the continued optimism brought on by improving economic reports.

-The Fed continued to keep the Fed Funds Rate near zero throughout the year in the hopes to stimulate growth, but was disappointed with the results.  The initial bond purchase program initiated in the depths of the recession came to a close in March.  After hinting at it in August, the Fed officially began a second quantitative easing program in November in an attempt to lower interest rates and promote borrowing to aid economic growth.  The Fed stated it would purchase $600 billion of US Government bonds and reinvest the proceeds from existing holdings coming due for another $300 billion pumped into the market.  The move helped power the US stock market forward over the last third of the year.

-Investors concerns moved from deflation to inflation over the course of the year.  Earlier in the year inflation reached its lowest level since the data was first tracked in 1957 and as of November the CPI has only risen 1.1% compared to a year earlier.  However, the recent Fed bond purchases have led many to expect inflation to begin to accelerate over the coming year.  The expectation of rising inflation and current low interest rates have led to Treasury Inflation Protected Securities to be auctioned at negative yields for the first time ever.

Corporate News
-Earnings grew throughout the year as firms began to see the benefits of the slowly improving economy and through their ability to cut costs.  However, U.S. companies were sitting on large cash stock piles throughout the year showing they still had a cautious attitude toward the economic recovery by not investing in plants or increasing hiring.

-Several corporations faced major problems in the year.  BP and Toyota faced PR and financial nightmares largely due to their own negligence, while Bank of America, JP Morgan and GMAC remained mired in a foreclosure mess.  The firms put a moratorium on foreclosures to review their practices that came under fire from Freddie Mac for poor documentation practices.  The fast processing and so called “robo signers” who signed off on hundreds of foreclosures without close inspection caused many to believe the process could be rife with errors.

Regulatory News
-After much wrangling on Capitol Hill the markets received another stimulus boost with the extension of the Bush era tax cuts in December.  Income tax cuts for all earning levels were extended 2 years, the estate tax was reduced, wage earners received a reduced pay roll tax, an extension of benefits for the long-term unemployed, and businesses get a large write off for new equipment purchases.

-In July, a new financial regulatory bill was passed in the biggest expansion of government power over banking and the markets since the Great Depression. The law restricts the actions of banks and other financial institutions, gives regulators new powers to seize and dismantle failing financial companies, bolsters the Federal Reserve’s authority over the country’s largest firms, toughens scrutiny over derivatives and creates a new regulator to police mortgages and credit cards.

-Several insider trading probes were led throughout the year with the current probe involving “expert network” firms selling inside information on companies to hedge and mutual fund traders and analysts across the U.S.

Market News
-Traditionally one of the strongest months for stocks, December did not disappoint with the Dow up 5.2% and the S&P 500 up 6.7% for the month on optimism over the recovering economy and the extension of tax cuts.  The Dow and S&P 500 reached levels not seen since August of 2008 as they rose 11.0% and 15.1% respectively for the year.  Almost all of the gains were achieved in the second half of the year.  For the year, growth outperformed value with the performance gap widening at smaller capitalizations and small cap vastly outperformed large cap 26.9% to 16.1%.  Real Estate was also a strong performer for the year up 28.1%

-International stocks rebounded in December rising 8.0% with additional assurances from the ECB to fight the debt crisis and European leaders agreeing on a plan to create a permanent crisis finance program.  The debt problems of Greece and Ireland, which eventually led to bailouts, and the concerns over whether the debt contagion would spread to other debt burdened European nations weighed on international stocks in the Spring and Fall.  The Euro fell as well under concerns the currency might not be able to withstand the sovereign debt issues.  For the year, developed and emerging markets remained in the black with developed markets up 7.8% and emerging markets returning 18.9%

-Agricultural and metal commodities were more volatile than normal over the year with many including coffee, sugar, wheat, gold, silver, and copper hitting decades old or new highs before inflation.  Many investors jumped into gold over the course of the year as a safe haven from concerns over the dollar and Europe.

-Bonds saw another down month in December as investors continued to pull out of bond funds, and specifically Munis. Muni bonds were battered over the final quarter of the year as treasury yields rose, government policy became uncertain and the fiscal situation of state and local governments became more precarious.  The Build America Bond program, which led to a large amount of Muni issuances, was not extended.  Performance was once again down across all terms and sectors for the month with intermediate term treasuries and municipals showing the worst performance between -1.5% and -3.4%.  For the year, however, all terms and sectors were up with corporate bonds fairing the best, returning 8.5%, and global bonds fairing the worst.

Index Performance – December and 2010
US Large Cap Stock (S&P 500)              +6.68%   +15.06%
International Stock (FTSE AW ex US)     +7.99%   +11.86%
US Broad Bonds (BarCap Aggregate)     -1.08%   +6.54%
US Government Bond (Barclay’s Govt)   -1.62%   +5.52%
Cash (ML 3Month T-Bill)                        +0.02%   +0.13%


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