2010 in the Books

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The S&P 500 rose +0.1% to 1,257.64 last week, extending its biggest December
rally since 1991 and boosting its 2010 gain to +13% after a +23% rise in 2009,
the biggest two-year advance since the Internet boom in 1998 and 1999. The
Dow Jones Industrial Average climbed 4.02 points, or less than +0.1%, to
11,577.51 last week, extending its yearly increase to +11%. On the week the
Dow, S&P 500, NASDAQ, and Russell 2000 returned +0.0%, +0.1%, -0.5, and –
0.7%, respectively.

An improving global economy and record earnings are helping U.S. stocks defy
predictions for a “new normal” of below-average returns. The Standard & Poor’s
500 Index rose +13% in 2010, bringing the advance since March 2009 to +86%,
the biggest rally for a comparable period since 1955, according to data compiled
by Bloomberg and S&P. The benchmark equity index posted the largest gain for
consecutive years since 1999.

Per a Bloomberg interview, “People are finally starting to say, ‘OK, maybe this
growth is sustainable,’” said Mark Bronzo, who helps manage $21 billion at
Irvington, New York-based Security Global Investors. “What we’re seeing at
the end of the year is that earnings growth has been good and most people are
conceding that it’ll probably be good in 2011.”

Pacific Investment Management Co. warned in May 2009 that returns on
financial assets would trail historical averages because of government budget
deficits and increased regulation. U.S. equities have returned +6.2% a year
since 1900 before dividends, according to inflation-adjusted data compiled by the
London Business School and Credit Suisse Group AG in Zurich.
Caterpillar Inc. (“CAT”), DuPont Co. (“DD”) and McDonald’s Corp. (“MCD”)
jumped more than +22% in 2010 to lead gains in the 30-stock Dow while
consumer and industrial shares drove the S&P 500 to a valuation of 15.8 times
reported profit, the highest price-earnings ratio since June. Stocks rallied after
the Federal Reserve pledged to buy $600 billion in Treasuries to stimulate the
economy.

U.S. gross domestic product expanded +2.8% in 2010, according to the median
estimate of 69 economists in a Bloomberg survey. Growth will slow to +2.6% in
2011 and increase to +3.2% in 2012, the forecasts show.

Bill Gross, co-chief investment officer of Pimco, which manages the world’s
biggest bond fund, said in a December 3rd radio interview on “Bloomberg
Surveillance” with Tom Keene that the “old normal” was growth of +6% to +7%
and the “new normal” is roughly half that. Mohamed El-Erian, the other chief
investment officer at Pimco, said in an e-mail on December 1st that the forecast
has a 55% to 60% chance of coming true. “We are running at a half-size-paper-
airplane type of economy as opposed to one with stable wings and full thrusting
jet engines,” Gross said.

The S&P 500 gained +6.5% in December, sending the gauge above 1,251.70
for the first time since September 12th, 2008, the last trading day before Lehman
Brothers Holdings Inc. filed the world’s biggest bankruptcy and prompted a -46%
drop for the benchmark gauge through March 9, 2009.

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The stock index fell -16% between April 23rd and July 2nd after credit downgrades
for Greece, Portugal and Spain spurred concern that global economic growth
would slow. Investors started withdrawing money from stocks after the May 6th
crash erased $862 billion of value in 20 minutes. About $90 billion has been
removed from funds that buy American stocks, according to the Washington-
based Investment Company Institute.

Per a Bloomberg interview, “You had kind of a perfect storm,” Michael Nasto,
senior trader at U.S. Global Investors Inc., which manages about $3 billion in San
Antonio, said of the May 6th crash. “It’s a positive that since then, nothing has
happened and we continue to grind higher.”

Equities started rebounding in July as better-than-estimated earnings at
companies from United Parcel Service Inc. (“UPS”), to Apple Inc. (“AAPL”) and
Ford Motor Co. (“F”) lifted confidence the economy is recovering. The S&P
500 has surged +20% since Fed Chairman Ben S. Bernanke’s August 27th
speech in Jackson Hole, Wyoming, where he foreshadowed the second round of
quantitative easing. The central bank said in November it will buy an additional
$600 billion of bonds through June, expanding on record stimulus of $1.7 trillion
in asset purchases.

Per a Bloomberg interview, “It was quite a roller coaster ride for the equity
markets,” said Mark Luschini, chief investment strategist at Philadelphia-based
Janney Montgomery Scott LLC. “Even though the economic picture got cloudy
off and on, the corporate picture continued to stay sunny and warm. Not only
have corporations cleaned up their balance sheets to be in wonderful financial
conditions, corporate profitability remained exceedingly healthy.”

More than 70% of companies exceeded analysts’ profit estimates in the third
quarter. It was the sixth straight period that many beat projections, the longest
stretch since at least 1993, Bloomberg data show. Balance sheets are the
strongest on record, according to Goldman Sachs Group Inc.’s David Kostin, who
cited data showing companies hold more than $1 trillion in cash, the most ever
compared with the value of their assets.

Based on predictions from 11 strategist in a Bloomberg News survey, the
benchmark gauge for American equities will rise +9.3% from its 2010 close to
1,374 in 2011, bringing the increase since the end of 2008 to +52%, the best
return since 1997 to 1999. “It’s been a turnabout,” Luschini said. “With the state
of the consumer seemingly not deteriorating anymore, coupled with the fact that
we are in an economic recovery, the most economically sensitive or cyclical
sectors should perform the best.”

The MSCI EAFE Index (broad international index) was up +0.7% last week. The
Americas were up +0.4% with Brazil up +1.2%, Mexico up +1.2%, and Canada
up +0.5%. Europe was down -2.0% with Germany down -2.0%. Asia-Pacific
was up +2.0% with Australia down -0.7%, China down -1.0%, Hong Kong up
+0.9%, India up +2.2%, and Japan down -0.5%.

Treasuries rose with the 10 year yield dropping to 3.30% from 3.40%.

The TED spread measuring the difference between LIBOR and Treasury bill
rates, which rose as high as 464 basis points during the liquidity crisis of 2008,
is currently in more of a normal range of 17 basis points. The TED spread is a
gauge of the willingness of banks to lend to one another. The lower the TED
spread the more willing banks are to lend with each other. The spread has been
widening lately due to concern about the quality of banks’ collateral amid the
euro-region’s financial crisis.

Oil was down -0.1% last week and closed at $91.38 per barrel. Oil was up
+15.2% in 2010. The average price of unleaded gasoline rose +1.0% last week
to end at $3.072 per gallon per January 2nd data provided by AAA. Unleaded
gasoline was up +15.9% in 2010.

Gold was up +3.0% last week and closed at $1,421.10 per troy ounce. Gold
was up +30.0% in 2010. The dollar was down -1.8% last week as measured by
the U.S. Dollar Index with that index closing at 79.028. The U.S. Dollar was up
+1.5% in 2010. The Euro was stronger against the dollar closing at $1.34/Euro.
The Euro was down -7.0% against the Dollar for 2010.

Look for earnings in the coming week from The Mosaic Co. (“MOS”), Monsanto
(“MON”), Family Dollar Store (“FDO”), and KB Home (“KBH”). Look for economic
data in the coming week on December manufacturing, November construction
spending, factory orders, December ADP employment change, December payroll
data including the unemployment rate (projected to come in at 9.7%), and weekly
jobless claims data.

Contributed by Hugh Smith from The Welch Group www.WelchGroup.com

Sources: Barron’s, Bloomberg, The Wall Street Journal, The New York Times, ValueLine.

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