Bottom Line

My January 2009 newsletter was titled Opportunities in 2009. Looking back, how true that turned out to be! On the whole, I had the right outlook going into the year but certainly left some room for improvement. Specifically, I predicted that November 2008 would not turn out to be a stock market bottom and that investor pessimism would instead peak sometime in 2009. This was correct. Still, I would have benefited from being more bullish at the March 2009 stock market low.

Here is the investment outlook that I proposed at the beginning of the year along with a grade ranging from A-F for each category:

2009 in review

I found it interesting to go back and reread my newsletters from January 2008, January 2009, and March 2009. Here are some relevant excerpts:

• January 2008 (pre-recession)

"I believe that one of the main themes for 2008 will be the continuation of the 2007 credit crunch. Subprime mortgages were only the first domino to fall in an otherwise much larger credit problem."

"I can't say for sure whether the financial sector will pull down the rest of the economy, but it sure looks that way so far."

"I don't know the true likelihood of a major credit meltdown, but the system has never really been tested yet. The potential for large stock market losses in 2008 certainly remains a possibility."

"It is unclear to me just how much risk there is in the current financial system, but my investment strategy right now is to avoid exposure to U.S. stocks and real estate until valuations become more favorable."

"Although I try to remain unbiased and focus on market fundamentals, I recognize that my current outlook for the U.S. economy is quite bearish. I don't anticipate a depression type of scenario, but a recession may certainly be in the cards in the near future. Either way, I expect U.S. stocks and real estate to underperform in the next few years. Unlike your stockbroker, at least you'll know that when I finally become bullish on U.S. stocks that my outlook is genuine."

• January 2009 (after the initial crash but prior to the stock market bottom)

"In my view, most of the 2008 credit crunch has run its course. Reverberations will continue, but the main earthquake is over. However, a slow economy and flat/falling prices in stocks and housing will continue to drain investor sentiment throughout the year. My personal guess is that investment pessimism (in this cycle) peaks sometime in 2009, which makes it a year of opportunity for investors willing to accept risk."

"A mixed investment outlook calls for a mixed strategy. Few places demonstrate compelling value, which is why moderate exposure to a variety of asset classes makes sense at this time. Investors should be on the lookout for 2009 to present some great buying opportunities, especially in the U.S. stock market."

"Perhaps November 2008 was ''the low'' and opportunities have already been missed. As I said, my guess is no, but I'm not willing to stake my entire portfolio on this view. Maintain some risk exposure at this level so that you won't be tempted to buy if prices rise, but keep some reserves in case valuations improve. Develop a mixed strategy for 2009."

• March 2009 (near the stock market bottom)

"On the whole, I reiterate my view that the stock market is priced to deliver adequate but not exceptional long-term returns. Consequently, I think being partially invested makes the most sense at this time."

"Personally, I do not believe we are headed for a Great Depression. But I respect the possibility that earnings growth may be slower than normal in the next 5-10 years. This certainly feels like a deep recession, but I haven't lived through enough of them to develop a strong intuition. My best guess: put me down for 80/20 towards No Great Depression."

"As for me, I'm somewhat interested in [a variety of asset classes], so I have a mixed strategy. Buy some stocks at this level, but otherwise stay liquid and build reserves to take advantage of possible stock market and real estate bargains in the future."

In retrospect, I had a pretty good investment strategy going into the year. There were certainly opportunities for investors willing to take risk. With perfect hindsight, the best strategy for 2009 was to stay out of the market until March and then go all-in for the rest of the year.

But the opportunity in March came and went in a flash. Although the S&P 500 is up more than 65% since hitting a bottom of $666 on March 9th, the index dropped below $800 per share for just a little over one month. Only investors with nerves of absolute steel were able to capture this 65% bounce. Consider that since January 1, 2009, the S&P 500 is up just 23% (not bad, of course, but more modest compared to returns calculated from the absolute bottom).

Rather than try to time tops and bottoms perfectly, I maintain that a more realistic strategy is to scale in as valuations improve and scale out as valuations worsen. I encouraged investors to scale in modestly during the October 2008 to March 2009 timeframe (see October 2008, January 2009, and March 2009) but by no means suggested that investors go "all-in". In my view, the stock market fell from ridiculously high valuations to just decent valuations. This did not warrant an overwhelming bullish view.

In the end, I view March 2009 as an intermediate low in an otherwise long-term bear market (see September 2009). If and when a major bear market bottom occurs (see May 2009), there should be observable signs like better valuations and rising volume. Investors will have time to recognize the new bull market and get on board.

Prediction review

I described Long-term Treasuries (Most Unfavorable, Grade: A) as one of the "danger zone" investments for 2009. This turned out to be quite accurate. The yield on 30-year treasury bonds bottomed around the turn of the year last year, rising from nearly 2.5% to over 4.5%. The price of the iShares 20+ Year Treasury Bond Fund ETF (TLT) spiked around this time last year and is down more than 25% in 2009:

Commercial real estate (Most Unfavorable, Grade: C) is still a bit of an enigma for me. The iShares Industrial/Office fund (FIO) is up 29.7% for the year. Not bad, but consider that the ETF is still down over 50% since inception in May 2007. I have been expecting to hear more on a credit crunch relating to commercial real estate loans, but the news on this topic has been underwhelming so far.

Residential real estate (Unfavorable, Grade: A) has been quite a bearish asset class for me since I starting writing in 2006 (see November 2009 for a good review), which is why my upgrade from "Most unfavorable" to "Unfavorable" earns an "A" rating. Home prices are still falling in most U.S. cities, but 2009 showed the first signs of stabilization. I still do not think we have reached "the bottom" in most markets, but I wrote in November 2009 that I would no longer discourage most potential homeowners from buying.

Financial stocks (Unfavorable, Grade: B) had varied returns this year. Some big banks like Goldman Sachs and Morgan Stanley were up over 100% for the year while others like Citigroup, Bank of America, and AIG are still in the gutter. On the whole, the sector underperformed. Vanguard's Financial Sector ETF was up only 18.8% for the year, compared to 27.9% for the S&P 500.

Technology stocks (Unfavorable, Grade: F) continue to mystify me. My worst investment prediction of the year was the underperformance of tech stocks. The Powershares Nasdaq Index (QQQQ) is up nearly 60% in 2009. Big name Nasdaq stocks had amazing years, such as Google (up 106.4%), Apple (up 145.6%), Baidu (up 231.9%), and Amazon (up 159.8%). It's not my investing style to buy stocks like Google at 40x earnings, but I respect the fact that big money was made in technology in 2009.

Broad stock market indices (Neutral, Grade: B) like the S&P 500 actually had a pretty good year, up over 25%. You may not remember, but sentiment was quite bearish at this time last year, making a neutral (rather than unfavorable) rating a contrarian prediction. Still, the indices performed better than I imagined they would.

Emerging markets (Favorable, Grade: B) had an outstanding year. The only reason I'm not giving myself an "A" rating is for not being more bullish. Emerging market ETFs with good years included China (FXI up 50.6%), Australia (EWA up 74.1%), Brazil (EWZ up 125.7%), Singapore (EWS up 69.2%), and emerging markets (EEM up 72.6%).

Consumer staples (Favorable, Grade: C) had somewhat of a boring year, up only 17.4% versus 27.9% for the S&P 500. Oil and commodities stocks (Most Favorable, Grade: A) had a good year overall. Crude oil prices have nearly doubled since January when I wrote: "If you have no exposure in this area, now would be a decent time to gain some." Gold and gold stocks (Most Favorable, Grade: A) had good years again. ETF performance include gold (GLD up 25.3%), silver (SLV up 55.4%), and gold stocks (GDX up 43.3%). Gold is one of the few asset classes with a positive return through the financial crisis. That's pretty impressive.

Conclusion

Making good predictions about financial markets on a year-to-year basis is tough. Give it a try sometime, and you'll see how quickly you can be humbled by the market. As Warren Buffett wrote: "Only buy something that you'd be perfectly happy to hold if the market shut down for 10 years." That's good advice, which is why I've been focused on identifying long-term investing cycles over the past few months (see September 2009, October 2009, and November 2009). Still, I learned a lot from 2009. I hope you did too.