2009 Year-End Review

“It was the best of times, it was the worst of times…” With due respect to Mr. Dickens and the opening line of his classic book, A Tale of Two Cities, the full year 2009 felt just like the quote. After the market experienced its worst year in seventy in 2008, expectations were hopeful that the new year of 2009 would bring a change in fortunes, but it certainly did not start that way. Although credit markets were improving with massive amounts of federal aid, the stock markets began the year with a rapid descent in price. The first ten weeks of the year saw the S&P 500 fall 25% on top of the 37% beating it had taken in 2008. Then, on March 9, just as many had given up hope on the country, economy and business, the tide started to turn and equity markets have been up strongly ever since.

In fact, the markets rallied so strongly that most broad stock and bond indexes not only erased their negative start to the year but finished 2009 with strong positive returns! For someone like me who has been in this business for 25 years and has seen a great deal of volatility in equities, this reversal of fate in 2009, although welcome, is still hard to fathom. Within such a short period of time, how can it be both the best of times and the worst of times?

Our job at Bill Few Associates is not to answer the deep philosophical question above, but to help you with your finances in both the good times and the bad. For many, that meant advising clients to do what they may have felt uncomfortable doing; like staying in a declining investment when it felt painful to stay put. Occasionally, we directed clients to invest even when no one could forecast that an end of the decline was in sight. We helped clients make tough decisions about changing spending and consumption patterns until the markets began to recover. By keeping people invested in the worst of times, we were successful in helping them prosper in the good times when the markets recovered. We did this not by timing markets, which no one can do consistently, but by recognizing that as painful as the last business cycle was, it was a cycle. We felt strongly that things would get better and our job is to use our insight and discipline to help people invest to meet their goals and objectives over the long-term. Most all our clients have long-term goals, but regardless of the goal or objective, in good times and bad, people need financial advice and investments to match.

Usually, our jobs are less stressful in the good times, but good advice is still often hard to take to heart. As the markets recover, changes to investments will need to be made. In the past two years, the long-term benefits of diversification were less obvious. During the massive sell-off, most all asset categories fell. In the past ten months, nearly all asset categories have rallied. Going forward, whether the economy and the financial markets continue to improve or double-dip into another pull-back, it is unlikely that all these asset categories will continue to move in lock-step with each other. Based on our research and the work of others, we think that returns from many categories of assets (like bonds) will be much lower than they were last year. Many equity categories are also likely to behave less uniformly in 2010. Style differences between growth and value stocks will differentiate themselves, as well as stock categories from large to small and international to domestic. For the long-term, international and emerging markets stocks and bonds will need to become a bigger part of many portfolios as they are becoming a bigger part of our daily world. We have a lot more insight we will share with you through your consultant. Remember that good investment advice is often contrary to what our emotions would rather feel like doing.

2010 Forecast – No Easy Fixes! So, allow me for a moment to ponder one more philosophical question: What new investment ideas resulted from this last bruising investment cycle? Well, as a practicing investment professional of 25 years, I have seen many new ideas come and go. Many in our industry are lured in by the false promises of “back testing” (using past data to forecast what your performance would have been in different investments) to develop the NEXT best thing. It seems that shortly after every crash, a savvy group of investment professionals solve two very important questions: How could you have made money in the last period of pain and how can you continue to make money going forward and avoid future pain? They pore through all the past data with perfect hindsight and construct portfolios that would have weathered the storm. Then, they use whatever “knowledge” they garnered from this process to construct an investment philosophy that they feel will be bulletproof going forward. Yet, if these folks are so clever, one has to question why they failed to get it right three years ago? There is not some key signal that will predict with accuracy each market event. Every market crash brings a temporary change in investment style and substance, yet these investment fads do not prevent the next crash and rarely work beyond the current market cycle.

I am highly skeptical that my industry peers have finally invented a better mouse trap. It has not been done in the past with any consistency and I do not think anything has changed. So, I have learned to be wary of anyone touting a new magical investment system (that back testing has proven!) that would have avoided the pain of the recent past. In bad markets people lose money, even Warren Buffet, and in good markets people make money. Our goal is to minimize losses on the downside and try to add value on the upside (within a client’s risk tolerance). I know that some (lucky) investor will be in the right place at the right time and avoid the next sell-off or even profit from it. However, I also know from history that their success is much more random that they realize. Good investment advice will always be a mix of diversification, contrarianism, valuation and most important, but least admitted, humility. I mean humility regarding the limits of our ability to forecast the future and humility about our ability to read the past and fashion a new way forward that will guarantee just the best of times and none of the worst of times. Life is complicated, the economy is complicated, and financial advice is complicated and unique to each individual. Our role is to provide you financial guidance in the best of times and the worst of times, because if you live long enough, you will experience plenty of both.

Wishing you a prosperous 2010,

Mike Kauffelt Chief Investment Officer