Wednesday, January 5, 2011

Fourth Quarter 2010 Letter to Clients: "Clouds on the Horizon"


I’m Still Bullish, But There Are A Few Warning Signs to Watch

My last quarterly letter to you listed “10 Reasons to be Bullish on Common Stocks”.

And, sure enough, we had a very nice rally in the fourth quarter, with the S&P climbing more than +10%.

So you would think at time when one of my predictions came true (believe me, there have been plenty of other times when I haven’t fared so well), I find myself a little uneasy about certain aspects of the recent stock market move.

Some of the same factors that lead me to be bullish in September are still in place, i.e. the fundamentals still support stocks. Here are just a few bullish signs:

  • Fed policy remains accomodative;
  • The recent tax legislation from Washington is really just another fiscal stimulus package that should boost economic growth;
  • The third year of a Presidential cycle is historically good for stocks;
  • Corporations remain flush with cash (nearly $2 trillion) that could be used for M&A activity;
  • Competing investment alternatives – money market funds and short maturity bonds – still are offering very little yield.

With valuations still reasonable relative to historic levels, stocks should continue to play an important role in most investors’ portfolios.

My concern, I think, is really more that the consensus view on the market has now shifted 180 degrees. Where most were bearish at the end of last summer, now most seem to be bullish.

For example, there is not a single Wall Street strategist calling for a down market in 2011. Not one. Individuals seem to be returning to the stock market as well – flows into domestic equity funds have turned positive for the first time in a number of months.

I could go on but I hope you get my point. The fundamentals for stocks look just fine, but bullish sentiment seems to be too prevalent. The current market offers opportunities, but primarily in those sectors that have lagged the broader market averages.

For example, large cap stocks offer reasonable valuations and in many cases attractive dividend yields. Names like Colgate; Procter & Gamble; Exxon; and IBM may not create excitement at your next cocktail party but they’re probably going to make you good money this year.

International stocks lagged U.S. stocks last year but growth prospects in many countries outside our borders are better than ours. Besides the emerging markets – whose biggest problems seem to be that growth has been too robust – some European countries also seem to be doing well, especially Germany. Now is the time to be thinking about adding to international exposure, in my opinion.

Turning to the bond market, I would ignore the nay-sayers and consider adding to intermediate maturity paper, especially in the municipal market. Space doesn’t allow me to go through all of my bond thoughts (please see my blog for more details: http://randomglenings.blogspot.com/) but sufficient to say I think bonds will continue to play an important role for balanced accounts.

Finally, away from the markets, the most recently passed tax package from Washington contains a number of important tax elements, especially with regards to estate tax planning. We have some expertise in this area, so please feel free to let me know if you would like to set up a meeting with one of our wealth management folks.

With best wishes for the new year,