Lessons from 2010: Bad News, Good Returns

Last Updated Jan 14, 2011 11:38 AM EST

This week, we're looking at the lessons taught by the market over the past year. One that jumped out was how the market reacted to all the headlines, and it wasn't like you would expect.

With the ability to know the news (though not stock prices) with 100 percent certainty, you'd think you could easily generate market-beating returns. To test this hypothesis, I take you back in time to December 31, 2009. With your perfectly clear crystal ball, you can foresee all of the bad news that happened. As you read the list, try to remember how your stomach was taking the news, and if you were ever tempted to react by selling stocks. And looking back, knowing all of this information ahead of time, would you have been a buyer or a seller of stocks?

  • Europe experienced a series of severe financial crises in what could be called a contagion. Greece and Ireland had to be bailed out, and there are ongoing concerns that Spain and Portugal will be next.
  • North Korea stepped up its aggressive actions against South Korea and continues its aggressive nuclear program, threatening global peace.
  • Iran's nuclear capabilities remained a hot topic, with the country seemingly moving closer to having the ability to produce nuclear weapons, but refusing to discuss it. This creates the threat of an Israeli preemptive strike.
  • The U.S. economy continued to struggle. The November unemployment rate of 9.8 percent was actually higher than the January rate of 9.7 percent.
  • Projections for the Federal budget deficit skyrocketed and along with it fears that rising inflation was inevitable. This led to dramatic increase in commodity prices, especially gold. And Congress would react at year end by passing legislation that would dramatically worsen the ongoing budget problem. Tax cuts were put in place, more stimulus spending was enacted, but no plans were made to pay for any of the costs.
  • In 2010, 153 banks failed, surpassing the total of 140 for all of 2009. This was the largest number of failures since 1992 during the height of the S&L crisis.
  • Gold increased from just over $1,100 to about $1,400.
  • Crude oil finished 2010 at $91 per barrel, the highest year-end figure since 2007.
  • The housing market continued to weaken. Sales of new single-family houses fell to a seasonally adjusted annual rate of 290,000 in November, more than 20 percent below its mark one year prior. The actual number of homes sold in November was 21,000, the lowest monthly sales figure on record.
  • Home prices rebounded off their 2009 lows in early 2010, but they fell when the tax credits expired. Affordability was reduced toward the end of the year as mortgage rates rose steadily in the final two months.
Individually, these items would be a negative for the U.S. stock market. Collectively, it would seem that they would surely send the market reeling. I'm confident that faced with the certainty of these events occurring, even the most disciplined buy-and-hold investor would find their discipline tested, and most investors would have reduced their equity allocation or perhaps even gotten out of the market altogether. Yet, despite this tale of woe investors in U.S. stocks were well rewarded. Especially well rewarded were those who invested in the riskier asset classes of small-cap and small-cap value stocks, where returns were well above historical averages. The same was true of REITs, despite the aforementioned housing market problems and the well-documented problems in commercial real estate. The above examples demonstrate that the economy and the stock market are two very different animals.

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    Larry Swedroe is director of research for The BAM Alliance. He has authored or co-authored 13 books, including his most recent, Think, Act, and Invest Like Warren Buffett. His opinions and comments expressed on this site are his own and may not accurately reflect those of the firm.