A 2010 equity portfolio

Over the next week or so, I’m going to write a series of posts about the shape I think a portfolio should have for 2010.  The yshould come in the following order:

–the likely course of the US economy in the new year,

–the current state of the stock market,

–what I think the consensus opinions about 2010 are, and

–(most importantly) where I think a portfolio should differ from the consensus in order to perform better than it.

At this point, I don’t have very strong opinions.  But I’ve always found that I begin to form them when I approach the issues in writing.  I hope that will happen this time as well.

There are some general conclusions that I think we can draw, though, even before more careful analysis.

1.  Certainly, there’s no reason I can see to expect that 2010 will be more emotionally trying than 2009 was.  At the same time, 2010 stands to be a more difficult environment to make money in, in the sense that the chance to profit from the panic of the first quarter of 2009 is unlikely to recur.

2.  The average yearly return in US$ on the S&P 500 has been about 9%-10%.  Another rule of thumb is that returns will be inflation + 6%.  I think it’s reasonable to ask whether you think returns will be higher than average in 2010 or lower. My answer would be higher.   Why?

We are in the early stages of recovery from a very bad recession that ended only a few months ago.  Stocks, which had been falling precipitously for almost two years, have been rising for about nine months in anticipation of renewed economic growth.  Upward trends like this typically last for at least two years or more.  Maybe this time will be different, but betting that this sort of history won’t repeat itself is almost always a losing one.

3.  Very large amounts of money remain on the sidelines in money market funds (which yield close to nothing).  Individual investors also appear to have switched large amounts of money from stocks to bonds–where they are very exposed to losses as and when interest rates begin to rise.  In prior market cycles such money has sooner or later reentered the stock market.  I expect the same will occur this time around.

4.  Invariably the Wall Street consensus is wrong about how the economy and the stock market will develop.  That’s not anything new.  It’s never 100% incorrect, however–no one’s perfect.  The real trick for an investor is to try to figure out how the consensus will be off the mark and to concentrate one’s bets against the consensus only in that area.

Remember, too, we don’t need to have opinions about everything.  In fact, we don’t want to have opinions about everything. We want, instead, to have a few well thought out opinions (even one really good thought will do) that are away from the consensus thinking and where our own research tells us there’s a very high probability that we’re right.

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