The Santa Claus Rally helped equity markets advance in December as did better-than-expected economic data and news that major recipients of TARP (Bank of America, Citigroup, Wells Fargo) will be able to repay the government.
The U.S. dollar made a drastic reversal early in the month on signs of improving economic data, most notably an encouraging November nonfarm payrolls report, which gave credence to the idea that the Fed will raise interest rates sooner than the market expects. The stronger dollar sent commodities, especially gold, lower. Meanwhile, the tight negative correlation between stocks and the dollar over the past several months seemingly weakened.
Riskier, or more volatile, asset classes made the biggest gains during the month. Both mid caps (represented by the S&P 400) and small caps (represented by the Russell 2000) outperformed of large caps (represented by the S&P 500) in December and all of 2009. After dominating all other asset classes in 2009, emerging markets continued to outpace large cap stocks in both domestic and foreign developed countries.
It should be little surprise that Information Technology and Consumer Discretionary were among the top performing sectors in December. The other top performing were Utilities and Telecommunication, which both benefited from investors seeking dividends amid low (virtually zero) yields on money-market funds and CDs.
The worst performing sector was Financials. Mega-banks repaying TARP funds is a reason for optimism indeed. But banks pressured prices by flooding the markets with new equity issuances to replace TARP capital. Also weighing on financials was the prospect of the Fed raising interest rates. Financials have greatly benefited from easy profits made by borrowing virtually interest-free capital and buying Treasurys to earn a risk-free rate.
Bonds finished the year with their worst month since October of 2008. The Barclays Aggregate Bond Index declined 1.88 percent in December. Treasurys took the brunt of the damage as heavy supply overwhelmed short-staffed trading desks that struggled to take bonds down. IEF was down 4.39 percent in December and 6.60 percent for the year. Credit and MBS outperformed Treasurys for the month, as did TIPS, which returned -2.09 percent.
--Peter J. Lazaroff, Investment Analyst
Cliff J. Reynolds Jr., Investment Analyst
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