Economic Report Fourth Quarter 2009

The purpose of the Economic Report is to detail the economic and market forces that have helped shape returns for the preceding three months. For this report, however, a longer term view is warranted. Not only did the fourth quarter of 2009 cap off a volatile year, it brought to a close a potentially historic decade. Looking at the decade as a whole provides some necessary context for recent performance and helps set expectations for the months ahead.

First, let’s consider performance, which was strong for the third straight quarter. The S&P 500 Index returned 6.04%¹ for the fourth quarter and a robust 26.46% for the year as a whole. This performance is all the more remarkable considering that the market bottomed in March 2009, with the S&P 500 down over 25% from the beginning of the year through March 9th.

As encouraging as 2009’s performance was, the total return for the S&P 500 Index was down approximately 10% for the decade.

Numerous commentators have debated the current market’s similarities to previous secular bear markets, including the early 1970s and the 1930s. The British newspaper the Financial Times² even went so far as to argue that the recently completed decade was the worst in the history of the financial markets. The UK, European and Japanese markets saw similar weakness during the decade.

Do not imagine, however, that the gloom is universal. For the emerging markets, the previous decade has been one of enormous success, particularly for Russia, China and India. According to estimates provided by Ned Davis Research, Inc³, Russia has enjoyed a secular bull market dating from October 1998 that has seen an 18.0% average annual return in real terms. India, since April 2003, has enjoyed a 25.1% average annual real return, while our nearest neighbors, Canada and Mexico have enjoyed longstanding secular bulls for most of the decade.

China in particular has seen ten years of unprecedented growth. Hamish McRae estimated in the British newspaper The Independent⁴ that China has grown from the world’s sixth or seventh largest economy to the second largest, behind only the United States. (China, according to McRae, is now the world’s largest automobile manufacturer, having recently nudged ahead of the US.)

So what does all this mean for US investors? What is the way forward? Here are a few major lessons the longer-term view provides.

We are in a secular bear market

With two speculative bubbles (technology and housing) sparking major slumps and flattening the decade’s returns, it is clear that the last ten years have been a secular bear market. The question is – are we still in one? Recognizing the transition from one secular environment to another is extremely difficult. According to some analysts, including Ned Davis Research⁵, the current secular bear has not completely unwound. If you share their secular outlook, it may make sense to balance exposure to the current rally with defensive strategies and diligent risk management.

Economic power is realigning

The United States is still the world’s leading economic power and we believe its financial markets are still the strongest, most liquid and transparent. However, if current trends continue, it will make little sense to call China, India and several other Asian and Latin American economies “emerging”. Rather they may soon be taking their place alongside the developed world on a substantially more level playing field than we saw in the 20th century. At the very least, the secular bull market in many of these economies, coupled with the secular bear in the developed economies, argue strongly for more global exposure.

Government policies and capital market structures will likely evolve

Federal government response to the Great Depression of the 1930s and the capital market regulation that followed dominated our economy for decades. With the economic recovery still in development and policy responses still ongoing, it is impossible to determine the ultimate impact of the financial crisis. It seems likely, however, that your investing future will require careful navigation in potentially uncharted waters for some time to come.

It is clear that we are in a period of extraordinary complexity where professional management, a global perspective and careful risk management are critically important. We thank you for the trust you have placed in us and we will continue to work hard to navigate the challenges and opportunities on your behalf.