With the closing of 2009 the first decade of the 21st Century has passed.  We have witnessed many life changing events in these past ten years: a terrible tragedy on 9/11/01 and the subsequent healing from this tragedy which reflected the strength of our great nation; a continuing evolution of electronics, the internet, and social networking which allows us to always be connected, for better or worse; and the bracketing of the decade with the bursting of two bubbles, beginning with the technology bubble and ending with the housing bubble, which set in motion the failure of Bear Stearns and Lehman Brothers, the  near collapse of  global financial systems, and contributed to the most difficult economic conditions faced by the United States since the Great Depression.  Truly never a dull moment.

In an effort to stem the damage in the financial markets and bolster the economy, numerous stimulus and rescue programs were enacted across the globe in late 2008 and 2009.  Stimulus packages included interest rate cuts, tax cuts, asset purchases by the Fed, increased government spending on infrastructure, first time home buyer credits, cash incentives for new car purchases and the trade-in of less economical models, government guarantees of loans, loan forgiveness, and easing of credit terms.  Implementation of these programs did indeed allow the healing to begin.  Economies continue to strengthen across the globe, while financial markets not only returned from the brink of disaster, but in the case of many equity markets, rallied strongly, pushing the S&P 500 Index to a total return of 26.46% and the Russell 1000 Growth Index to a gain of 37.21% by the end of year.  For equity investors the year began in dismal fashion as stock prices plummeted in the first two months of 2009 before performing an about face in March.  March was just the beginning of the reversal as the rally extended through the remainder of the year.  The second and third quarters of the year represented the strongest legs of the rally, with performance being led by lower priced, lower quality, low price-to-book, and low price-to-earnings companies.  In the fourth quarter the pace of the gains moderated.  A gain of 1.93% for the S&P 500 Index in December contributed to a 6.04% return for the quarter.  The Russell 1000 Growth Index leapt higher, producing a total return of 3.09% in December and 7.94% in the last calendar quarter.

Standing at the starting block of the new decade what can we expect in 2010?  There are plenty of signs the economy should continue to expand, but the recovery road will not be without its ruts.  Helping to spur growth will be the release of already approved stimulus dollars which have yet to be spent.  The employment picture is mixed, job losses have narrowed, however, many companies have become much  more efficient during the downturn and wary managements will be loath to return payrolls to previous levels.  Global manufacturing has been making steady progress, in the US the manufacturing Purchasing Managers Index rose to 55.9% in December, the highest level in more than three years, benefiting from a rebuild in inventories and stronger global demand.  Gains were also seen across Asia, the Eurozone, Russia, and Brazil.  Further gains will likely be limited by a desire to manage inventory at lower levels.  Growth in the much larger services part of the economy has not staged as strong a recovery and is likely to continue to be somewhat slower as job growth will remain difficult and a retrenching consumer will keep a closer hand on their wallet.  The housing market is on the mend, but the process will be drawn out.  Existing home sales rose above expectations in December, while inventory declined to 6.5 months of supply, but the median sales prices was down 4.3% year-over-year.  Price pressure is likely to continue as many who may have been waiting to sell start to enter the market.  On the flip side, new home sales deteriorated in December, dropping 11% while prices also moved lower.  From a company specific perspective we expect a gradual return of top line to lead to steadily improving earnings throughout the year as streamlined operations allow for margin expansion and greater contribution to the bottom line.  Corporate balance sheets have improved as many have raised cash levels and refinanced debt at lower levels.  With the available cash, the desire of companies to broaden market opportunities, and still reasonable valuation levels, merger and acquisition activity is likely to remain strong.

The major theme for the October start of the fourth quarter was “mixed.”  Economic data and company reports rocked back and forth between positive and negative. The month started with disappointing jobless claims, a weak ISM manufacturing report and a large drop in auto sales due to the end of the cash-for-clunkers program. Job losses continued with the September number at 263,000 versus a 201,000 August number. In these times, rumors have had a disproportionate affect. In October the rumor was that the Chinese, Russians and French were working to reprice oil from US dollars to a basket of currencies. After heightened activity in the dollar and gold, the rumor subsided. Later in the month the rumor was that there was a conscious effort by central banks to increase inflation modestly to reduce the burden of public debt. If true then traders will sell dollars and buy commodities. Positive announcements included a number of chain-store reports, strong trade data from China, and solid industrial production numbers. To this were added good company profit reports by Caterpillar, 3M, McDonalds, PNC, Travelers, Capital One, American Express, Microsoft and Amazon. Certain positive data such as a large increase in existing home sales could be tied to a Federal government stimulus program. Overall the first estimate of third quarter GDP came in at a strong 3.5% (later revised to 2.2%) in spite of a generally weak employment market with unemployment then running at 9.8% (later to rise to 10.2% and then fall to 10%). Another looming negative is bank balance sheets flush with cash, as loan issuance is not expanding the way government officials had hoped, yet funding continues to be a challenge for small companies.

November began with three notable economic numbers showing a strong growth trend, but in continuing the “mixed” theme, looking at the details took much of the hope away. Specifically, the ISM’s Manufacturing Index increased to a 55.7 from 52.5. However, this came with a warning that the important new orders sub-component continued to slow. Likewise, construction spending increased by almost 1% from the previous month which was revised downward significantly. Last, pending home sales increased over 6%, but these “sales” have recently not led to commensurate increases in existing home sales due to stricter underwriting standards. Positive indicators for November would include Cisco earnings, chain-store sales and productivity gains. Another positive would be the continuing rise in exports fueled by the weak dollar. There is increasing focus being placed on two events. One is the FOMC’s so-called “exit strategy,” that is, when will the Fed tighten its reins on the economy by raising rates and generally being less accommodative. To date of course this accommodation has been extreme. The Fed has indicated that it will keep rates low for an extended period of time. The second is the exit of the Fed from the mortgage market where it owns in excess of 20% of agency mortgages. Additionally, the two most vexing areas remain - jobs and housing - where volatility is most apparent. This was shown later in the month when initial jobless claims continued a week-to-week decline. But it was accompanied by deep declines in housing starts and permits. The day after Thanksgiving it was announced that a large investment firm, Dubai World” would be asking to restructure part of its debt of $80 billion. This was complicated by the government of Dubai’s decision not to honor the debt of this state-owned firm. The fear was that these actions would cause a negative ripple through the financial world. However, the crisis passed quickly when Dubai reversed its decision and made a $10 billion bailout.

As the Dubai flap receded, the financial markets rose and there was a shift back to risk taking. Spreads in the fixed income markets tightened greatly this year particularly in the high-yield market where a record $150+ billion in new issues have been brought, year to date. Economic news in December was generally good as ADP’s payroll count improved, a strong month-to-month growth in new orders in the non-manufacturing sector and payrolls having a very small decline. Adding to this were reports that retail sales were better in November, inventories had their first increase in over a year and industrial production was solid. Later in the month FedEx reported excellent results and exports continued their strong growth.  On the government front it was announced that the bank bailout will cost the taxpayers $200 billion less than previous estimates while the TARP rescue program was extended to October 2010. In addition there was the executive announcement of $150 billion of spending increases and tax cuts. Internationally, Greece suffered a credit rating cut and Austrian banks were suspected of being over-exposed in Eastern Europe. Turning to the Federal Reserve, the Fed continued its low interest rate policy although it did test the system whereby it could withdraw reserves from financial markets. Some of the inflation numbers such as producer and consumer prices were higher. Housing remains mixed with existing home sales up sharply (90% of total sales) while new home sales were down late in the month. Housing starts are up modestly reflecting a slow recovery in this area. On the plus side, the month finished out with a robust increase in Chicago Purchasing Managers Report and the Jobless Claims fell to 432,000, the lowest since July, 2008.