Positive Vibes!

With a new year approaching, it is time to reflect briefly on this past year and look ahead. Let’s first consider bonds and how they reacted during the year. With a drive to reduce interest rates by the Federal Reserve Board (FRB), we saw short-term interest rates approach 0% and longer-term rates drop to new 30-year lows, thereby increasing the value of bonds. This situation dominated for most of the year until the FRB decided that they wanted to see a higher rate of inflation and began dumping money into the economy in November. This has resulted in interest rates rising and the value of bonds decreasing in value. Assuming that the FRB continues in this vein, moving more fixed investments into shorter duration positions--where the risk of inflation is lower but the returns are also lower--will be necessary. This will be good news to stock prices that should advance in 2011, as investors look for higher returns and leave bonds to invest in stocks. Stocks also have the attribute of tending to move, over time, up with inflation. In 2010, stocks made progress in price increases, but with a great deal of volatility. If we look at the gain in the S&P 500 from the close on January 4, 2010 until the close on December 20th, we see the index move from 1144.98 to 1247.08, or about 6.3% gain for the year. Not great, but not bad either. Stomaching what was happening during the year was difficult. With the S&P falling from the beginning of the year to 1022.58 at the close on June 28, or a drop of about 10.7%, some investors found it difficult to hang in during such a large correction! Currently, the stock market has been moving up and is likely overbought (prices too high). A small correction in the range of perhaps 2% is likely over the short run, but we are in a bull market that still appears to have a long way to go. In summary, it appears that investing in bonds with maturities that go out more than 5 years could be a bad idea in 2011 if inflation increases, but investing in stocks will likely be a good idea, assuming that we do not have any major domestic or international incidents. Many investors became frightened during 2007 through 2009 and went very conservative with their portfolios. During 2009 and again in 2010, the conservative investor did well, as bonds reached new 30 year lows. It appears that this will not be the case in 2011 as the bonds may lose value or achieve small gains. Investors need to review their willingness to take risks and consider reevaluating their risk profiles. I would like to take this opportunity to wish you a healthy and invigorating New Year! Ed Mallon