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Year End Review

December 29, 2009 – 9:53 am

At the end of any fiscal year most investors look back at the year and study the best investments that they missed.  A lot of people take guidance from these figures and allocate money to the areas that worked best.

This action usually ends up being a poor decision.

When a certain investment or investment category leads the pack one year, the vast majority of the time the following year that same investment will be a laggard.  It happens year after year.  Stocks that rise a huge percent one year usually lose momentum.  When a particular investment category shatters the performance of the indexes it is nearly impossible to repeat such a feat the following year.  In 2008 treasury bonds were the killer investment, but if you held them through 2009 then you would have simply been killed.

So what were the best categories this year?  Junk bonds and emerging market stocks.

Both categories are up well in excess of 50% on the year, but do not expect those returns to repeat in 2010.  Junk bonds were beaten up so badly in 2008 due to overly pessimistic expectations for defaults.  Sentiment however gradually moved into the more optimistic camp throughout 2009 and caused the market to rally dramatically.  The scenario that set up such great returns is no longer in play and therefore a great return from the junk bond sector in 2010 is highly unlikely.  Will they have a negative return next year?  I would not rule it out, especially with the likelihood of higher yields by January 1, 2011 than we have now.

Emerging markets stocks also did very poorly in 2008 due to two factors.  In 2007 the category did very well and momentum ran out in 2008 when it was clear the U.S. economic slowdown would affect foreign economies.  In addition, the dollar performed very well in 2008 as the global credit crunch hit and caused many investors to flee to the safety of the dollar.  In 2009 the dollar consistently fell as our government announced monstrous spending programs to get us out of the economic slump.  However, the dollar looks poised to have a much better year in 2010 as the Federal Reserve is likely to start tightening its monetary policy, draining much of the stimulus it laid out at the end of last year.  A rising dollar is good for emerging market stocks as they export their cheaper goods to us next year.

Emerging market stocks have very good prospects for next year, but I would limit the exposure because they also had a successful 2009. It might be a rough ride next year.

A strong dollar and improving economies will likely be the theme for next year so your job is to determine what stocks and sectors will do well in that kind of environment.

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