Fourth Quarter 2009 Commentary and Year-End Review
By Robert Stimpson, CFA
Portfolio Manager
Oak Associates’ Q4 2008 Market Commentary concluded with the sentence: “We look forward to the strong performance which tends to occur following markets characterized by high risk aversion.” At that time, we could not have anticipated how succinctly the statement would articulate the past year. In the fourth quarter of 2009, the S&P 500 rose 6%, capping a strong year for US stocks. For the full year, all Oak Funds significantly outperformed their individual benchmarks, with returns ranging from 36% on the low end to 79% for the highest-performing fund.
The Return to Normal
The US stock market entered 2009 reeling from financial turmoil of 2008. The carnage from the sub-prime fallout, the Wall Street bailout, auto industry bankruptcies, and capitulating economic data overwhelmed not just stock prices, but fueled extraordinarily high levels of risk aversion. Indeed the decline in the fourth quarter of 2008 rivaled that of the 1987 stock market crash. When perceived market risk is high, stocks are shunned, regardless of valuation, the outlook, or the prospects of a recovery. Cash and government securities are preferred. This reactive process can clearly be seen by the VIX Index, a quantitative measure of volatility in stocks using inputs from the options market. The index, which has traded between 10 and 40 over the last 15 years, closed at an all-time high of over 80 in fourth quarter of 2008. By December 2009, the VIX index had steadily dropped to 19.
The VIX Index’s return to normal underscores the abatement of risk aversion that had depressed stock prices in 2008. The stock market’s recovery was driven by stability in the banking sector, the fiscal and monetary stimulus enacted over 12 months ago, and a rapid recovery in global markets. Economic data throughout much of 2009 still portrayed a bleak economy, but this is typical due to its backward-looking nature. The stock market, however, looks forward and eagerly anticipated the economic recovery.
By mid-year 2009, the market had seen a bottom in March, banks were seeking to return TARP bailout money and leading indicators were recovering. The rebound in the market coincided with the easing of mark-to-market accounting practices for illiquid securities, which had exacerbated the subprime and financial crisis of 2008. Once the stock market had turned the corner, investors wanted to own stocks once again and assumed more risk.
2010 Outlook
US companies acted quickly during the recession to right-size operations and protect profit margins. This bodes extremely well for investors heading into 2010. As the global synchronized recovery progresses, corporations are likely to benefit from the strong operating leverage produced by high profit margins, rising revenues, and a reluctance to raise capital spending. Not only will this produce better-than-expected earnings and year-over-year growth rates, but stocks will benefit from the higher valuation multiples assigned to those cash-flows. This combination tends to be very powerful for stocks. Additionally, the return of stock buy-backs and merger and acquisition activity could also enhance equity returns.
While we don’t anticipate another 50%-plus year for growth investors in 2010, there remains room for the stock market to rise further. Indeed, the stock market’s rebound out of a recession tends to last anywhere from 6 to 8 quarters. The two risks worth watching in 2010 will be the threat of inflation and the government’s intentions to depart from the loose monetary conditions it has created.
As usual, predicting the path of the stock market is always hazardous. Instead, we prefer to prepare the portfolio for the economic conditions we expect to prevail. Given the strength of the stock market rebound, it is likely at some point that the Federal Reserve will at least publicly contemplate unwinding the economic and monetary stimulus. Other global central banks have already started hiking interest rates, particularly those with heavy commodity related economies. While an actual increase in short-term US interest rates may not arrive for some time, the debate over its timing and the fear of inflation may thwart the market in mid-year 2010. Inflation is unlikely to be a true economic problem, but rather an academic one, due to the still weak labor markets and output gap. Until these risks become more tangible, we remain focused on attractive valuations, global opportunities and the risk/reward proposition that is strongly skewed in favor of the long-term investor.
As mentioned in last year’s Year-End Review, the stock market is well versed in financial crisis. Once again, it has not only survived, but it is thriving. The 2008 sub-prime crisis will now join the Savings & Loan crisis, the Latin American currency revaluations, the Russian-debt default, the Asian contagion, the Long-Term Capital Management implosion, the WorldCom/Enron accounting crisis of confidence, and the dot-com bubble, as just another speed-bump over the last 20 years of investing.
This manager commentary represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice.
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The performance data quoted represents past performance and does not guarantee future results. Investment return and principal value will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than the original cost. Current performance may be lower or higher than the performance quoted. Performance data to the most recent month end may be obtained by calling 1.888.462.5386. Expense ratios are: Black Oak: 1.76% (gross); 1.35% (net); Live Oak: 1.52% (gross); 1.35% (net); Pin Oak: 1.51% (gross); 1.25% (net); Red Oak: 1.58% (gross); 1.35% (net); River Oak: 1.76% (gross); 1.35% (net); Rock Oak: 1.56% (gross); 1.25% (net) and White Oak 1.41% (gross); 1.25% (net). The Advisor has contractually agreed for a period of 1 year from the date of the prospectus to waive all or a portion of its fee for the Funds in order to limit Black Oak; Live Oak, Red Oak and River Oak’s total operating expenses to 1.35% and White Oak , Pin Oak and Rock Oak ‘s total operating expenses to 1.25%.
The S&P 500, Russell 2000 and NASDAQ 100 are unmanaged indexes. The indexes do not reflect any management fees, transaction costs, or expenses. Investors cannot invest directly in an index.