Two Trends That Will Continue in 2006, and One that Won't

For those that survived the year that was, some congratulations are in order. After living through the bird flu scare, horrific natural disasters, and an inverted yield curve, one must wonder what the next twelve months hold.

Investors will likely see a number of familiar themes in 2006. Last year ended a six-year winning streak for small-cap stocks over their large-cap rivals, and considering the late stage economic expansion the U.S. economy is currently experiencing, this trend should continue. Smaller stocks are now more expensive, and have less earning momentum, than larger issues, which leads me to believe that equity investors will be better off concentrating on stocks with large capitalizations.

Investors are also likely to see continued dominance of foreign stocks. As international bourses fought for leadership in equity returns in 2005–Europe’s Dow Jones Stoxx Index rose 24% in 2005, outpacing a 22% gain in the Morgan Stanley Capital International Asia Pacific Index–the S&P 500 index registered a paltry 3% increase. While the return differentials may not be as dramatic in the New Year, I do think that U.S. markets will not lead in 2006. The main drivers for foreign outperformance include increases in global expansion, which should continue to boost international commerce.

And as for a trend that won’t continue, I believe that the Fed will finally stop raising interest rates in 2006. With borrowing costs high enough to keep inflation contained, lower energy prices, and some questions about the strength of earnings, fixed income strategies should regain some of the luster they lost in 2005.