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A classic stock in the high Beta portfolio was Las Vegas Sands. LVS started 2009 at a price of approximately $6 a share. By mid-March it had fallen to $1.42 a share on credit crunch concerns, which resulted in a work stoppage on its Cotai Strip Project. However, as credit markets thawed and its default no longer loomed imminent, it began a truly "generational" move to close the year above $16 a share. While some investors buying at the low secured the elusive "10" bagger over a few months, LVS still returned over 200% for the entire year, consistent with the results for high Beta stocks in 2009. This stock summarized the difficulty of the 2009 investment environment. Moreover, owning classically prudent stocks did not pay handsomely in such a volatile environment. We were very grateful that the AFG 50 portfolio closed 2009 outperforming the S&P 500 by approximately 450 bps. While every year one beats the market is an accomplishment, last year was particularly rewarding considering the challenging market conditions.
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So looking ahead to 2010, is the Beta trade likely to persist? We think not. The following chart looks at the returns of high versus low Beta portfolios over the last 10 years. The interesting thing to take note of is how the Beta effect tends to reverse itself following a particularly robust cycle such as 1999 and 2004.
Notice that in general, high Beta stocks have not tended to outperform their less volatile siblings. However, when they do, the return differential is very dramatic. The other interesting thing from this chart is that following those dramatic "Beta Effect" years in 1999 and 2004, the Beta effect tended to reverse itself significantly. Clearly 2009 is a strong "Beta Effect" year, and assuming nothing changes as the year unfolds, we expect that lower Beta stocks should enjoy relative outperformance in the months ahead, as the riskier stocks take a breather from their dramatic '09 run.
The economic environment for 2010 should provide many interesting discussions for us as the year unfolds. While economic activity has certainly picked up over the past few months, it is hard to have a positive intermediate-term view of the economy given the ongoing uncertainty created by Washington. Ultimately, the economy needs consumers, but with reported unemployment at 10%, and "all-in" unemployment closer to 17%, it seems unlikely that consumers will provide an ongoing boost to economic activity without job creation and growth. That last bit "“ job creation - is the tricky part of the whole equation. From a macro perspective, it seems that until things clear up regarding new regulations and taxes, businesses will be very timid about adding new workers. After all, it is virtually impossible to hire without understanding the total compensation one must pay to a new worker or the after tax profit such a worker can generate. With health care reform still undefined, it is difficult to see employers adding workers in significant numbers in the short-term. Additionally, the possibility of new taxes for energy, probable higher interest rates later this year, and higher income and capital gains taxes for 2011, will likely make employers take additional pause until these issues become more transparent. So for now, we will act like a responsible economist and say that "on one hand", low interest rates provide a very attractive economic environment, "but on the other hand", interest rates are only low because the underlying structure of the economy is fairly lousy. Bottom line, we are not likely to make a major bet on the economy at this point in time.
Regarding the overall market, things are just about as confusing as the underlying economy. While in 2009, we consistently hammered on the theme that the market was silly-cheap based on the profit and growth expectations priced into it, we cannot make such a claim today. The chart below updates our analysis of the expectations built into the S&P 500 stocks.
While the sales expectations are not obscene, they by no means are flashing an "all systems go" signal given the uncertainty still floating around the economy. While we would say we are cautiously optimistic about the market, we are more cautious than optimistic at this point.
We conclude this month with a quick review of our notable forecasts from last year. In general, we did very well with our predictions. Here they are:
1. The return of valuation as an important stock selection factor: Valuation will regain popularity although investors will remain guarded about risks. Stocks with attractive valuations and manageable leverage, large and small, will outperform the overall market. Investors have fled to safety by purchasing stocks with high dividend yields, low leverage, and positive trading momentum. As investors shift their focus towards the long-term, stocks currently trading at deep discounts to their future expected cash flows should outpace the overall universe, as we experienced in December(2008).
2. Sector preference reshuffling: Investors will look for and be able to find more bargains in cyclical sectors, such as consumer discretionary, technology, and basic material. Consumer staples will remain a safe haven but become less appealing as investors get ready to embrace higher returns at appropriate risks.
3. Inflation concern resurfaces: By the end of the year, the Fed will be more concerned with inflation than deflation, due to the stimulus efforts and the tremendous amount of cash injected into the economy in 2008 and over the coming months.
4. Stronger household balance sheet: US households' total debt outstanding will continue to shrink as American people continue to pay down their debts. This voluntary de-leverage act will make the overall economy's GDP growth recovery longer to materialize, but good for the long-term financial well being of average families.
While Beta was clearly the driving factor behind profitable portfolios in 2009, valuation performed admirably. The return spreads between the top and bottom value score quintiles for the Russell 1000 was 22.37%. If only every forecasting exercise could be as reasonable as last year's. For this year, we are not making direct forecasts ourselves, but rather will share the various predictions of our recent Market Forecast Project Survey.
Here is a summary of the predictions for 2010 from the Market Forecast Project Survey:
We asked our survey participants:
"What is your prediction for the U.S. Economy for 2010?"
Responses were:
"¢ Fair
"¢ Muddle through
"¢ GDP up 3.5%
"¢ Unemployment remains elevated, and in the second half of the year, rises again.
"¢ I can't imagine it will be great once the stimulus dries up but this year proved me wrong so many times, who knows.
"¢ GDP +3.1%
"¢ Plus 3%
"¢ Strong first half with multiple challenges in the second half
"¢ GDP +6%
"¢ Continue to grind it out, under 3% GDP growth.
"¢ GDP less than 3%
"¢ Continued improvement at a crawl pace
"¢ Positive GDP Growth as money multiplier rebounds
"¢ GDP will grow by 2.5% by the end of 2010.
"¢ Strong 1H weak 2H tax increases and higher interest rates etc. become headwinds
"¢ Sluggish growth of 2.5%
"¢ GDP positive 3.5%, but unemployment staying above 9% until 4Q
"¢ GDP expansion q1, currency crisis q2, deteriorating q3/4
"¢ Strong first half growth, slowing substantially as the Fed withdraws monetary measures.
"¢ GDP = +4.2%.
"¢ 3% growth
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