Third Time’s a Charm

Once is a fluke. Twice is a Trend. Three times is a charm.

That’s what the S&P500 is looking at right now, a chance to make it three in a row with another annual gain in 2011.

The first year was probably the easiest, 2009’s big bounce from the bottom that saw stocks move into the green after a brutal start. But that led to questions about sustainability; was some sort of rebound inevitable or does the market have the legs to keep chugging higher?

Well, the answer turned out to be yes, but it definitely didn’t come easy.

2010 was a tough year to be in business.

It got off to a rocky start with Greece spiraling down a fiscal toilet, placing the entire European Union and its currency on the brink of Martial law.

Next up was an oil spill in the Gulf that threw the energy industry into disarray.

That was followed by another season of Iran trying to go nuclear.

And then, in the back half of the year, the market saw a pivotal midterm election, tax deals playing into the ninth inning, and, oh ya, North Korea just fired a missile at South Korea, and now South Korea is pissed.

Try creating a forecast when you have day-to-day uncertainty in key markets.

What will taxes be next year? Not sure.

How much will energy cost? Not sure.

What about sales? It depends on taxes and energy.

But when it was all said and done, the market had once again fought its way to the top of the mountain for another annual gain, making it a back-to-back affair in the face of serious pessimism and uncertainty.

And it wasn’t a coincidence.

The Private Sector is Lean and Mean

 The S&P500 is a battle-tested bunch, asked to tighten its belt and hit the tread mill in 2008 and 2009 in order to survive a very cold and dark winter. And keep in mind, the problem with the economy was never the private sector in the first place; it was in the financial sector and housing, which means companies that were already strong were asked to get even stronger.

And now, that extra conditioning is paying off.

The S&P500 is in position to eclipse peak earnings from 2007, fueled by record margin expansion as companies do really fun things like outsource jobs and increase productivity. Record margins make the private sector more profitable than ever.

The S&P500 is also a financial fortress, with close to $2 trillion in cash sitting on the balance sheet. That provides unbelievable financial flexibility to protect, invest and grow.

If anyone’s scratching their head right now, I know why.

“This doesn’t sound like the usual pessimism; I thought the economy was bad?”

That’s actually true; the economy is a bit weak right now. But there’s a very specific reason for that.

The S&P500 and private sector in general have become extremely global, with operations and employees spread all across the world. That means a lot of jobs and paychecks that used to hit the American economy now show up in international markets like China and India. IBM is the perfect example, employing just 45% of its 410,000 global workforce in the United States.

Adding fuel to the fire is the productivity binge that companies have been on for the last two years. More productivity means fewer jobs, which also weighs on GDP and unemployment.

These are the stark realities of the global economy, not very encouraging from a domestic perspective, but critical for every investor to understand in order to play accordingly.

Good Things Never Come Easy

 But even with the tail winds of strong corporate earnings and upward momentum supporting the market, 2011 will present its own unique set of challenges.

There are still plenty of questions about the sustainability of China’s economy.

The European Union continues to bail water at a breakneck pace, but Euro-zone bond yields speak of continued weakness.

And we certainly have our fair share of problems at home, with a huge federal deficit and weakness in housing lurking on the horizon.

These are macro-level issues that are beyond anyone’s ability to control or forecast. For the time being, we’ll leave that to the policy and deal makers.

The task that falls to us as investors is finding great companies that can adapt and thrive in a very dynamic environment. Innovative companies creating new technology and industries that will benefit from a global population boom that is pressuring all kinds of natural resources.

But in order for our portfolio to produce gains we first need to focus on building a strong foundation, which is where we’ll turn our attention next week; anchor stocks, stocks designed to provide stability to the portfolio.

In the meantime, here are two articles for thought. The first is a piece from AP that discusses how the global labor force has affected the American economy. The second one is a little more upbeat, some really great tips on how to get your portfolio tuned up as we make our way into the new year.

Where are the Jobs? For Many Companies, Overseas

Top 10 Investing Tips for 2011

Your Investment Partner,

Mike

ABOUT THE AUTHOR

Michael Vodicka

Michael Vodicka is the president and founder of the Vodicka Group Inc., a licensed investment advisor (Series 65) and a financial journalist.