BCN ADVANTAGE: 2010 ANNUAL REPORT
For 2010, the DJIA was up 11.0% (closing at 11,578), the S&P 500 was up 12.8% (closing at 1,258) and the Nasdaq was up 16.9% (closing at 2,653). We endured a wild ride that saw two significant corrections, the first beginning in mid-January, taking the markets down -8.1%, the second beginning in early May, taking the markets down -16%. As late as mid-September, stocks were essentially flat for the year. Finally, in the first week of September, the markets bottomed, with the major indexes reversing and closing out 2010 at multi-year highs. Given the outright destruction wrought by the markets over the past 10 years, few investors were willing to sit tight in early May when the markets began to fall apart. The infamous “flash crash” on 5/6/2010 was initially written off as a technical glitch. In a matter of minutes, the DJIA declined by 600 points (nearly 1000 points on the day) and the stocks of 8 major companies in the S&P 500 fell to one cent per share. Twenty minutes later, the Dow had regained most of the 600 point drop, but the roller coaster ride had barely begun. It is interesting to note that over 21 months, the rally that began in March 2009 has experienced more corrections (declines of at least 5%) than any market rally in decades. Through April 2010, we remained fully invested – even during the January/February decline precipitated by the sovereign debt crisis in Greece (the first of many). We made the decision to exit the markets on 5/19/2010, with the S&P 500 at 1,115. Six weeks later, the major indexes hit their low point for 2010 – a decline of -16% from April and a hairs-breadth away from a full-blown bear market. Following a snap-back rally in July, the markets rolled over again throughout August. The S&P 500 did not regain the 1,115 level until mid-September, 4 months after our decision to go defensive. The indexes did not regain their April levels until early November. Clearly, this was a major market correction. According to their November announcement, the Fed will take 8 months (through June 2011) to inject roughly $100 billion per month into the economy. This is in addition to QE1 – the program initiated in March 2009 (at the very beginning of the current rally) to purchase $1.7 trillion in Treasury and mortgage debt. Quantitative easing of this magnitude is unprecedented, with the Fed essentially creating a huge asset bubble in stocks by printing money. We will likely remain fully invested through the end of April 2011, but possibly longer if economic fundamentals begin to show real (sustainable) improvement. The next major correction (-20% or more) will occur when the Fed is ultimately forced to reverse the money flow and begin taking the $2.5 trillion in monetized debt (printed money) out of the economy. I cannot conceive of any exit strategy where artificially inflated asset prices do not decline precipitously once the Fed reverses course. My job is to have you safely back on the sidelines before that happens. For many reasons, we do not believe the current rally is a new long-term bull market. Corporations cannot grow profits indefinitely by cutting their labor costs. The country faces seemingly intractable unemployment (net 7 million jobs lost since 2008), and ongoing problems with real estate and the debt markets (residential mortgages, along with a new threat from munibonds). The now chronic European sovereign debt “crisis” will continue to flare. And most telling, related to all of the above, is the dearth of initial public offerings. From 2003-2007, new issues averaged more than 200 per year, topping out at 276 in 2007. In the three years since, new issues have totaled just 212 – particularly concerning given that new businesses are the lifeblood of job creation and economic growth. 2010 was a frustrating year, but understanding the ramifications of unprecedented Fed behavior takes time. Our fundamental strategy remains unchanged. The highest priority is to minimize losses – like we did in 2008. The “mathematics of loss” can be unforgiving: A 25% loss requires a 33% gain, just to break even. A 50% loss requires a 100% gain. Because of our outperformance in 2008 and 2009, BCN Advantage clients can profit even in years like 2010, when we missed the September rally.
