Fear ruled the markets in 2011. Investors fretted that the Great Bear Market of 2007–08 would return, accompanied by another economic downturn. By August the S&P 500 had given up all the gains made in the first half of the year and was dropping rapidly into the red. Thank you, European crisis.
Volatility has been another buzz kill. The widely followed VIX Volatility Index tripled from near 16 in July to as high as 48 by early August, while markets looked like they were free-falling into the netherworld.
Ultimately, the Chicken Little scenario did not play out. Instead we witnessed one of the sharpest recoveries in decades in January of this year, which continued through February, with the Dow Jones industrial average now at its highest point since the spring of 2008.
There are a number of good reasons for the rebound. First, we are slowly coming out of the worst Depression since the 1930s. Despite the cries from “gloom and doomers” such as Harry Dent, who has recently written that a “Great Crash” is directly ahead, stocks are at their lowest values in over 20 years.
Company balance sheets are strong, and earnings approaching record levels. A second important reason is inflation, which is coming. The budget deficit, accompanied by the Fed’s QE1 and QE2 programs, doubled the national debt held by the public since 2008, and the deficit will be up well over a trillion dollars again in fiscal 2012.
Smoldering inflationary fires will burst into an inferno once the unemployment rate falls below 7.5%, if not sooner. In this environment good stocks, not Treasurys, are the place to be. So forget the risk of flight to Treasurys trade. Rising inflation-primed interest rates will send bond prices plummeting.
Turning to 2011 calls: My stock picks lagged the S&P by more than 3% last year, although over the past three years I am still ahead by nearly 2% annually. My worst picks included Hartford Financial Services Group (NYSE:HIG), down 37%; Encana (NYSE:ECA), down 34%; Banco Santander (STD) down 23%; and HSBC (HBC), down 22%. The financials and oil exploration companies have already bounced back from their lows, year-to-date.
Overall I stand by my 2011 calls. I am a contrarian value investor and not a timer, and it’s not unusual for my picks to be “early.”
My outperformers in 2011 included Marathon Oil (NYSE:MRO), up 37%; Pfizer (NYSE:PFE), up 28%; Altria (NYSE:MO), up 22%; Chubb (NYSE:CB), up 19%; and Allstate (NYSE:ALL) and ConocoPhillips (NYSE:COP), both up 11%. I would continue to hold Chesapeake Energy (NYSE:CHK), Marathon Petroleum (NYSE:MPC), Petrobras (NYSE:PBR), Apache (APA) and Devon Energy (DVN).
Also hold on to JPMorgan Chase (JPM), and HSBC, Hartford Financial and BHP Billiton (BHP).