Where we stand II

First, a very happy New Year to everyone. I hope everyone enjoyed their holiday week(s) and some time off (I did). We are going to try something a little different this week. For the next week or so, I will post everyday about something. Whatever catches my eye will get mention, whether it is in depth or simply an observation.



As I struggle to write a missive to clients, it appeared that putting some historical perspective on 2008 might be in order. The stock market, as measured by the S&P 500 index, showed its second worst calendar year on record:

As painful as this year was, it doesn't come close to the worst twelve-month periods in history (monthly basis), the top five of which range from -52% to -68%!

One theme I have followed closely all year is the bearish sentiment surrounding the U.S. dollar's value. It appeared to be a nearly universal opinion that the dollar would fall. When sentiment in either direction is so overwhelming, it can pay to be a contrarian: the trade-weighted index of the dollar vs. foreign currencies was up 8.6% for the year.

Speaking of foreign currencies, many suggested increasing allocations to foreign stocks last year based on the premise that the dollar is going to fall, emerging economies are growing faster and foreign stocks had cheaper valuations. Well, those strategists were wrong on all accounts: Non-US stocks fell 53% according to the Dow Jones indexes with only Switzerland and Japan doing slightly better. We can also measure foreign market performance in local currency terms, which means ignoring fluctuations in exchange rates (local market performance from the perspective of someone living in the country of that market). In local currency terms, foreign markets contracted some 47%. That means not only were expectations for the dollar wrong, but fundamental performance of foreign markets was weaker than the U.S. Out of the major foreign markets (developed countries with large markets), only the U.K. and Switzerland did better (and not by much).

Also of note, is that the yield on the 10-year U.S. Treasury bond ended the year at a mere 2.25%. For comparison, the indicated dividend yield on the S&P 500 is now 3.1%. This is the first time since 1957 that stocks yield more than the 10-year T-bond. It appears wherever one looks these days extreme conditions exist- an indication of just how abnormal the current state of affairs is.