Top Five Portfolio News Stories of 2010: AdvisorOne

The “flash crash” that kicked that event into occurring is said to be a kick of a lantern by a cow in Mrs. O’Leary’s barn, according to urban legend. The true cause has never been established.

But Chicago’s rapid-fire destruction and Phoenix-like recovery is telling. Many people lost their lives in the fire, just as many got rich in the re-building.

Lesson: Know that “black swan” events occur and have disparate impact. Waddell & Reed, whose trade brought about the flash crash, was extremely adversely affected whereas all those investors who had gotten out of the market because of the credit crisis crash were completely unaffected.

There’s no more reason to worry about the next flash crash than about a “dirty bomb,” a rogue trader or the sudden collapse of a large European market like Spain’s. Broad asset-class diversification will help investors going into a crisis and opportunistic buying will help them recover and maybe even thrive.

European Woes

The sovereign debt crisis in Europe was the first significant dampener in the 2010 bull market’s march toward recovery.  Worries about a host of problems, beginning with Greek bonds of diminishing credibility, then moving to Ireland’s failed banks and a national budget ill equipped to bail them out, have tested Europe’s incipient euro-based credit union.

While Greece was the story in 2009, the Irish troubles roiled markets in April and May and worries about the soundness of Portugal, Spain, Italy and Belgium loom darkly behind debates of how the eurozone can adapt its economically unbalanced economic sphere.

In all likelihood, the crisis and its impact should only grow in the new year. Greece and Ireland are among the smaller EU countries. The debts of a large European economy like Spain are far harder for EU’s money centers to cover, and the assets on the books of Spanish banks are no better and maybe worse than the CDOs that nearly took down the U.S. economy.

Europe lacks the bedrock harmony, strained as it is, that the U.S. possesses. Germans do not feel a kinship with Mediterranean peoples, and are therefore more perturbed, if possible, than the U.S. public on the subject of bailouts.

Individual European countries are also divided internally on a host of problems, especially immigration, but also broad economic questions such as the proper age of retirement; societal expectations of a state-supported easy life are greater there than in the U.S. and thus economic realities will hit the average citizen harder. In short, Europe and economic and societal crisis are a bad mix, a precursor to war historically.

Lesson: Just as political risk in U.S. Treasuries is a negative “new normal,” we take a stable and peaceful Europe for granted at our peril. The first and most important rule of investing is diversification, and that includes geographic diversification.

There are many sound globally-oriented European companies that will do well whether or not the countries in which they are domiciled are experiencing problems; and there are other companies that could be more affected by, say, work stoppages amid domestic unrest. Be wary of poor credit quality among European debt securities, and spread your risk far and wide among equities.

Metals Mania

The best news for investors in 2010 may be the magic in metals. Not just gold, but silver, copper, platinum, even recycled scrap metal, have gone up, up, up. Mining companies have also brought eye-popping returns. But this story is just the flip side of all the bad news that has worried investors in 2010.

Metals generate no cash flow, add no value, create no wealth. As SoGen analyst Dylan Grice wrote in an attention-getting recent report:

“A bushel of wheat, a lump of iron-ore or an ingot of silver today is identical to a bushel of wheat, lump of iron-ore or ingot of silver produced one thousand years ago. The only difference is that they’re generally cheaper to produce because over time, human innovation has lowered the cost of production. When you buy commodities, you’re selling human ingenuity.”

But they’re real assets that store value in a world where the value of things we once depended on are in undeniable decline. When the credit quality of U.S. Treasuries, of all things, is permanently impaired; when computerized technical glitches can cause plunging values; when the economies of sizable European nations become a house of cards; and in the broader economy more generally where land is more like quicksand — people are attracted to values that are tangible.

As Ken Fisher pointed out, economic woes of this kind are part of the normal human condition, and to that end those who invested confidently as he did in the U.S. stock market were happy campers this year.

Still, it should worry us that metals and mining were among the top gainers, and one hopes that innovation of the kind that has propelled tablets, smart phones and mobile web applications to 2010’s biggest investment winners will be dominant themes in 2011.

Lesson: The market aphorism that “the trend is your friend” is certainly true. Oodles of money were to be made in every direction emanating from the initial thrust into gold and beyond to miners, other precious metals and the whole lot of industrial metals.

But many investors arrived late to each of those parties, missing the biggest gains. Rather than eat the appetizers, they ate their hearts out. There’s something to the old idea of investing in a broadly diversified portfolio including growth stocks, dividend-paying equities and commodities, and turning attention to friends, families and hobbies that bring joy to life rather than worrying about the price of rhodium.