2010: Scaling the wall of worry

By the time the ball dropped at Times Square last New Year's Eve, US investors had plenty to celebrate. Large cap stocks, as measured by the S&P 500, were up over 15 percent for the year while small cap stocks, as measured by the Russell 2000, gained almost 27 percent. Even the much-maligned dollar put in a respectable showing, rising nearly 7 percent against the euro and almost 4 percent versus the British pound (though it fell more than 14 percent against the Japanese yen.) It was a very good year.

But investors didn't earn these returns easily. As stocks climbed their wall of worry, investors had to brave significant volatility while ignoring the incessant blabber of doomsaying pundits. (Remember Glen Beck's tearful pleadings or the somber intonations of Anthony Robbins?)

They also had to exercise real patience. As late as August the markets were firmly in negative territory. Not surprising, it was in August that the pundits were at their worst. As the following graph illustrates, those who chickened out in August had their gooses cooked by the rally that followed. The market gained more than up more than 20 percent between the August lows and the end of the year.  

During this entire episode, the market gave investors plenty of reasons to fret. In a brief retrospective on 2010's returns, Weston Wellington of Dimensional Fund Advisors highlighted some of the things that probably had many investors wringing their hands. Here is his list:

  • A prominent researcher who had predicted the Great Recession was expecting the "biggest co-ordinated asset bust ever."

  • An Economist cover story in January warning of asset price bubbles asserted that US stocks were "nearly 50% overvalued."

  • The "January Indicator" signaled poor stock market performance for the remainder of the year.

  • A tragic drilling rig explosion in April produced a disastrous and hugely expensive oil spill in the Gulf of Mexico.

  • A bewildering "flash crash" on May 6th saw the Dow Jone Industrial Average plummet 1100 points in the course of a few frantic minutes.

  • Hundreds of bank failures revealed continued weakness in the financial sector.

  • Congress passed a complex and potential expensive healthcare reform bill.

  • Residential housing remained weak, with monthly sales of new homes falling at one point to their lowest level since 1963.

  • An obscure technical indicator dubbed the "Hindenburg Omen" generated a "sell" signal in August.

  • North Korea launched a deadly artillery barrage in November against South Korea's Yeonpyeong Island.

  • A financial crisis with no clear solution gripped governments in Greece. Portugal and Ireland.

Any one of these problems could have been ample reason for weak-kneed investors to run for the hills, but of course, that would have been a terrible mistake. As markets scale their walls of worry, they often move in steps, going sideways for a while before making a bold move upward. 2010 was no exception. If we want to earn the return for the risks we take in the investing process, we have to be invested when the market makes its move.

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(Weston J. Wellington, "Achieving Market Returns in 2010" January 2011)