The 2010 stock market was a roller coaster ride with almost all of the gains coming in the last few months of the year.

Here is what $100,000 invested in the S&P 500 Index looked like throughout the year.  In July the stock market was negative by over 13%!

Also note that the stock market was in negative return territory almost 40% of the year!  That ‘red’ performance took its emotional toll on investors as domestic equity fund flows, according to the Investment Company Institute, were negative in the first 50 weeks of 2010.  Not until the final two weeks of the year did the stabilization of the markets rekindle investor interest in stocks.

The volatility that is a hallmark of the 2010 stock markets wasn’t confined to just the US markets —ALL markets were volatile!

Here is the $100,000 chart adding the emerging markets index (EEM) and the commodities index (DBC).

During May through July, emerging markets and commodities indexes were negative by almost 20%.

Foxhall Capital’s 2010 Performance

Given the difficulty in managing money while riding on the 2010 stock market roller coaster, I am very pleased that all of Foxhall’s EQUITY strategies produced POSITIVE RETURNS in 2010.

The Foxhall Global Conservative Strategy and Foxhall Global Balanced Strategy were heavily exposed to the ‘flash crash’ effect on convertible and high yield bonds when both lost approximately 10% in value in just three weeks in May.  Since that crash, the broad bond markets have produced no net return through the end of the year so recouping the loss from the extraordinary situation in May was more than the equity component could manage in these two strategies.  The Foxhall Global Growth & Income Strategy, with 25% in bonds and 75% in equity did overcome the bond losses to finish the year with a small gain.

At Foxhall Capital—Risk Management Is A Key Philosophy!

When we see a stock market like 2010 with volatility at historic levels over 20% and a stock market erratically moving from positive gains to negative losses every few months, Foxhall, by policy, tries to reduce volatility and the possibility of significant client portfolio losses by increasing the percentage of cash and US treasuries in all of our portfolio strategies.

While we make no apologies for trying to protect our client’s portfolios in a roller coaster stock market, in hindsight, we may have been too conservative.  We may have kept too much cash and US treasuries in the portfolios for too long and that policy had an overall negative impact on 2010 performance.  Hindsight is the key word here. During the times that Foxhall’s risk management efforts were in effect, there was wide spread talk of a “double dip” recession and other gloomy economic prognosis.  Though Foxhall’s investment management process is not predictive, the extreme and persistent volatility indicated that the markets “agreed” with the ‘prognosticators’ and Foxhall’s process reacted accordingly.  It is simple enough to make that observation several months after-the-fact but it was also ‘simple’, at the time, to maintain the discipline of the investment process and reduce stock market exposure for the purpose of reducing investor exposure to possible significant loss. 

During the last two quarters of 2010, the markets stabilized and Foxhall was fully invested.  Risk in the markets waned and Foxhall Global Equity Strategies ended solidly positive for the year.

Foxhall Pacific Rim and Emerging Markets Strategy

The Asian and emerging markets were negative almost -20% at mid-year.  The Chinese Shanghai Stock Market Index ended negative -16% for 2010.  However, Asia and emerging markets have been climbing higher over the past few months and I believe this is now a discernable and sustainable upward trend.  This Foxhall strategy was up more than 7.00% for just the month of December.

The Foxhall Global Hard Asset Strategy was Foxhall’s best performing strategy in 2010.  In December alone this Foxhall strategy was up over 10% and almost 10% for the year.  As with Emerging Markets, we are seeing a discernable and sustainable long-term upward trend in global commodities.

The Foxhall Global Growth Strategy combines global developed markets with emerging markets and global hard assets.   As was mentioned above, the gains for the year in the U.S. and overseas developed markets began in substantially negative territory in July.  By year end, Foxhall Global Growth managed a positive return of approximately 5% and did so with less volatility than the markets.

Stock Market Predictions For 2011…

I believe we will see three major investment trends in 2011 that should produce solid gains for Foxhall’s investors.

Trend #1:  Global US Brands Should Drive The U.S. Stock Market

Despite all the doomsayers, the U.S. economy and U.S. stock market should be up in 2011.  I predict overall modest growth in the economy of about 3% to 3.5% and unemployment should remain stubbornly around 9%.

But, I also believe new jobs will be added, exports will increase, productivity will increase and those U.S. global companies and brands that are selling to newly affluent markets in Asia and other emerging markets will do very well and they will be the main drivers of the U.S. stock market in 2011.  If there are no terrorist attacks, no new wars or some other disaster, I think 2011 could be a very good year for globally-oriented U.S. stocks.

Trend #2:  Asian & Emerging Markets Should Grow Three Times Faster Than The U.S. & Europe

I believe that after an erratic 2010, Asia and emerging markets are now in a long-term secular bull market trend and this will continue for some time.

Even more money is likely to be directed into Asian and emerging markets as investors around the world realize that emerging economies on average are growing three times faster than developed economies, and generally have more foreign reserves and lower debt-to-GDP ratios than most developed countries.

The International Monetary Fund has estimated that all emerging markets will grow an average of 7.1% in 2010 and 6.4% in 2011, well above the 2.7% and 2.2% growth (in 2010 and 2011, respectively) estimated for all developed markets.  India should grow over 9% and China may grow over 10% in 2011.  Meanwhile, foreign reserves in China are the largest in the world, totaling more than US$2.6 trillion, while India and Brazil have more than US$250 billion each in U.S. dollar reserves.

Although the slowdown in the global economy had an impact on some Asian and emerging markets, we are seeing that these economies are becoming more domestically driven.  Private domestic consumption and government expenditure in areas such as infrastructure have at least partially offset the impact of decelerating export growth.  The services sector has, in my view, also been gaining in importance, especially in China and India.

Generally, I also believe the economic recovery in emerging markets is likely to be sustainable in view of their strong fundamentals.  In addition to robust macroeconomic data, financial and fiscal indicators remain positive.  Moreover, the search for higher returns in a low interest rate environment in the U.S. coupled with attractive valuations in emerging markets could continue to support strong stock market performance.

However, emerging economies are starting to face inflationary pressures.  In addition, if central banks in emerging markets continue to buy dollars to prevent their currencies from appreciating too quickly, thereby increasing their foreign reserves, they may appear increasingly safe to investors looking for markets with higher economic growth and yields.  Monetary and exchange rate policies around the world could also impact markets, and so we continuously track the situation.

How Will China Do In 2011?

For example, in 2010, China has aggressively moved to tighten lending to real estate and to significantly raise interest rates to dampen inflation.  I think China is doing everything right at the moment to manage their economy so the growth does not spiral out of control.  I wish we had the problem of too much growth in the U.S.

The Chinese Shanghai Stock Exchange Index was down -16% in 2010.  But this stock exchange is heavily weighted in banks and real estate investment companies and so the Chinese government’s policies restricting  real estate loans and purchases affects banks and real estate companies disproportionately.

Because it is hard for foreigners to invest in China, Foxhall has a relatively small direct exposure to China.  However, China is still the growth engine of Asia and the world and the smart investments in China are often indirect investments in commodities and through other Asian markets like Hong Kong, Singapore, Taiwan, Korea and Vietnam.

What About China’s “Housing Bubble?”

That all being said, I believe the concerns over China’s so-called “housing bubble” have been vastly overblown.  I just returned from a month in China and I had many conversations with Chinese analysts and the Chinese Central Bank.

Here is the real story.  A bubble implies that prices rise to unsustainable levels and then crash, which I do not think will be the case in China as a whole.  The country is huge and the property market is quite varied, so one can’t make a simple analysis. 

A few facts may clarify why I think the situation in China now is quite different from what led to the subprime crisis in the U.S. a short while ago. 

• In China, home buyers must first put down approximately 20-30% of the total value in cash as a down payment before they can get a mortgage on their primary residence.  They are limited to only investing in 3 other investment properties.  Investment properties require up to a 50% cash down payment.

• The ratio of consumer lending to GDP is about 17% in China compared to 94% in the U.S. and 56% in Hong Kong.·

• Household leverage is also substantially lower in China, at about 26%, versus 124% in the U.S.

 Differentiation is important within China’s real estate market.  Sharp price increases have been concentrated in the major coastal cities of Shanghai, Beijing, Shenzhen and Guangzhou.  But those cities represent only about 8% of the national urban population and 8% of total residential property sales by floor space.

More than 150 other Chinese cities have a population of one million or more.  But in other cities prices have not moved very much at all. 

Another important point to note is that the rise in overall property prices in China has more or less tracked the rise in household income.  While the real estate market may have taken on bubble-like characteristics in some specific areas, the government has been quick to react, to control and prevent bubbles, such as introducing measures to restrict bank lending on second and third home purchases.  But overall, I don’t think the Chinese real estate market is in dangerous territory in terms of a bubble. 

Asian and emerging markets, like most other global equity markets, will, of course, experience corrections along the way.  However, over the longer term, Asian and emerging markets should reflect the underlying strong economic growth in those countries.

Trend #3:  Commodities Should Continue Their Outperformance As Inflation Starts To Raise Its Ugly Head And the Emerging Market’s Insatiable Appetite for Commodities stresses supplies

Everyone knows that housing prices are estimated to go down another 20-plus percent through 2014 when the bottom is being predicted.  Many analysts feel we could see a double-dip in housing prices in 2011.

Why is this important?  Because housing prices make up 32% of the calculation of the U.S. inflation index called the Consumer Price Index.  Housing also makes up 42% of the calculation of the U.S. Core Inflation Index.  This index does not include food, oil or gasoline prices.

The Core Inflation Index is used to determine cost of living increases for many pensions and social security.  It is also used to determine the inflation rate yield in inflation-adjusted U.S. treasuries (TIPS).

But because of the 42% calculation in declining housing prices, and the fact that this index does not include food, oil or gas, the U.S. government would like you to believe there is no inflation in the United States.

But anyone who has bought groceries or gas at the pump lately knows there is inflation.  Every businessman knows that the cost of his raw materials is going up, as is health care costs, education and just about everything else—except housing prices.

Starting in 2011, commodities are going to become an important tool in offsetting the loss in “buying power” in investor’s portfolios.

If you add back food, oil and gasoline and use the U.S. government’s pre-1980 inflation calculation, we have about 8.5% inflation right now.

China, Asian & Emerging Markets Are Big Buyers Of Commodities

Most of the popularly accepted predictions about China were wrong in 2010.  I also expect this to be the case again in 2011. 

In 2010, many predicted that Chinese exports would be slow.  Actually, export growth showed a 30% increase.  Predictions of 6% GDP growth turned out to be way too low.  China’s GDP grew about 10% in 2010.  Predictions of low growth of commodity imports into China were also too low.   Commodity imports turned out to be increases of 10% to 40% depending upon the commodity (coal, copper, iron ore, etc.).

In 2011, China, the rest of Asia and other emerging markets will continue to import massive amounts of goods, especially raw materials (coal, copper, iron ore, gold, nickel) and foods ((wheat, corn, soybeans, and rice). 

India and other emerging powers will also import large amounts of grains.  Keep an eye on food prices worldwide as they may continue to rise.

What does this mean to investors? Physical commodities and the companies that provide resources to China, India and other growing nations or companies that mine raw materials will continue to be an attractive investment area in 2011.  

Gold and silver shot up in 2010 and may experience a short-term pullback, but I believe gold and silver will do well longer term. 

Summary

Unlike most of 2010, I believe we will see the sustained, long term stock market trends that started over the past few months continue through 2011.

The Foxhall Global Growth Strategy has it all.  It is invested 60% in large developed stock markets, 30% in Asian and emerging markets and 10% in physical commodities and commodity producers.

For investors who want to increase their investments in the fast growing Asian and emerging markets, I strongly recommend our Foxhall Pacific Rim & Emerging Markets Strategy.

And like 2010, I expect the best performing strategy for 2011 to be the Foxhall Global Hard Asset Commodity Strategy.  This strategy is going to become a really important tool in the future for investors to maintain the dollar “buying power” of their investment portfolio that will be destroyed by inflation.

 Until then!

—Paul Dietrich

dietrich@foxhallcapital.com

800-416-2053