It is time for my annual financial self-examination.  I do this each year and make my findings public to create personal accountability.  2009 was much better than the 18 months before.  My aggressive total portfolio lost 50% in 2008.  In 2009, I reversed that horrible trend and gained back a good part of what I lost.  And for all of 2009, through Thursday, December 24, I ended the year at +40% (all numbers are Year Over Year), beating the SP500 and FFFDX (Fidelity Freedom 2020) indexes by a considerable margin (+20%, and +14%).  And from the March 7 bottom, I gained 126% (showing just how deep my portfolio had sunk in 2008 and early 2009, -65%).  The only way for those kind of gains is commitment and staying with your long term strategy.  At the panic bottom in early 2009, many were getting out of equities and going to bonds.  They still are there.  My performance was aided by a continuing commitment to commodities, tech and emerging markets.  I also tripled my commitment to high yield (junk) bonds and financials near the generational lows in March, which helped my overall return.   A couple of speculations, such as buying General Growth in April as it entered bankruptcy protection also paid off. 

As bad as 2008 was, it is really the past ten years that have been very poor for investments of almost all kinds.  Those who say we are at the beginning of a multi-year bear market really haven’t done their homework.  The Bear began in early 2000 with the collapse of the Tech bubble.  The Nasdaq 100, which was as high as 5100 in March that year dropped below 1100 in October 2002, a collapse that rivals the Dow Industrials collapse from 1930 to 1932.  Yes, the markets recovered (as they did in 1933-36), and the Dow Industrials, really an old-world and narrow index today, did reach new all-time highs of 14,200 in October 2007.  But the Nasdaq stocks barely recovered to 50% of their all-time highs (a classic Fibonacci retracement).  The bubble transferred from equities to real estate in the mid 2000s.   Of course, it was here that historic damage was done over the past two years.  

Given all this, I take some very small satisfaction in being down only an average of (-1%) annually for the past ten years in my overall portfolio.  This is especially true because much of my capital contribution was at the end of the period (2006-07) making the subsequent drop that much more damaging to my portfolio.  During the same ten year period, the SPY (-0.63%) and the FFFDX, a life benchmark portfolio for people retiring in 2020 (+2.23%) have better performance.  I am biased to the optimistic side of investing and comfortable with risk and so have a “higher beta” portfolio than most my age.  But had I seen the 10 year bear to rival the 1930s coming, I might have just left my investments in a bank account.  Hindsight is 20/20 so I am not second-guessing myself, and am happy to have kept up with passive index funds. 

It is a perilous but fun exercise to predict events over the course of a year.  It is impossible to really know the future, but mentally stimulating to give it a try.  And the result helps shape decisions throughout the year.  Here are the Wealth-Ed.com predictions for 2010:

1. The American stock markets will rise by 10-15%, defying the consensus which considers the market to be either fully or over-valued as of December 31, 2009 (too far, too fast).  SP500 will reach 1,270 during 2010 and will end the year close to that level; range will be 9500 – 11,300 DOW; 1020 – 1270 SP500; 1980 – 2490 NDQ 100;
2. SP500 aggregate earnings will exceed consensus expectations of $65-75.  They will finish the year at $85 which will justify a 1,275 SP500 price based on a PE of 15
3. The stock markets will follow the classic pattern of strong in winter and fall and weak in the late spring and summer which is the source of the saying: “sell in May and go away”; it will be a good year to follow that advice
4. The US dollar will strengthen into the second week of the new year and will then fall through the winter months as Treasuries are sold to finance riskier equity investments;  there are a record $8.4 trillion dollars on the side lines in cash, money market and other near money funds (as measured by M2, according to Fed Reserve report H.6); the dollar will drop to $70 DXY by the end of March and then rebound in the late spring so DXY (dollar index)  will exceed $80 by September.  An improving economy and higher Treasury rates will be the impetus for dollar strengthening
5. The Fed will hold short term interest rates low until mid-summer; it will allow long term rates to drift higher and the 30 year Treasury will hit 5% by June;  by July, the Fed will begin to signal its intentions to let short term (Fed Funds) rates increase as the economy continues to strengthen and the unemployment rate finally starts to decrease (first in June); evidence of higher interest rates will push the stock market down and the dollar will strengthen;  the 10 year Treasury (the basis of many mortgages) will finish the year over 4% from a current 3.5%;
6. As the dollar weakens to 70 DXY in the first half of the year, the “carry trade” will re-appear from its Holiday hiatus and weak dollar investments will excel, including Energy, Materials and Emerging Markets; but sell those investments in April as the dollar shows signs of reversing; TBT will be a very good way to play the reversal in the dollar (ultra short the Treasury complex); by October, the shock of higher interest rates wears off and the stock market picks back up with domestic and cyclical stocks taking the lead from the weak dollar stocks of the year’s first half; advice: rotate investments away from commodities and towards cyclicals and industrials as dollar strengthens at end of year;
7. Healthcare stocks continue their comeback as the Senate finally gets a greatly weakened bill passed in January.  It goes back to the House for conference and is finalized by the end of March.  The public option is gone but the expanded Medicaid program remains bringing another 30M people onto the public funded program.  Healthcare stocks continue their recovery with more people to receive care in 2010 and beyond; buy UNH, WLP, BDX, MDT, MRK, JNJ and PFE early in the year
8. Gold reaches its peak early in the year at 1400.  Gold bugs are crushed when the dollar strengthens later in the year.   The Fed proves to be much more adept at taking liquidity back out of the market than was anticipated by doomsayers and gold falls back below $1000.  Severe inflation (over 5%) never materializes due to the global production and labor overcapacity
9. Oil prices range between $60 for a low and $100 for a high in 2010; the low will occur in the late spring or early summer as winter demand dissipates and the dollar begins to strengthen with the beginning of tighter money supply, but though “weak dollar” speculation dissipates, the price peaks at $100 as the economy picks up pace at year end;
10. Natural gas outperforms oil as record supplies are reduced and demand begins to exceed supply by year end; gas ends 2010 at nearly $8 per mmcf  propelling the natural gas oriented production companies back to 2005 levels; PWE reaches $30 in late 2010 (was as low as $6.50 in March; I have stayed with this for the round trip);
11. The Republicans gain seats in both the House and the Senate as Independents that voted for change in 2008 are sorely disappointed in what is delivered and vote for economic stability and a balanced budget which the Republican party promises.  Enough seats are gained so that the Democrats lose their supermajority in both houses.  Awareness of this political shift is what fuels the market to new highs from the summer doldrums, starting in October.

Regarding 2009: I was in such shell-shock from the beating I took in Q4 2008 that it was January 3 before I got to my annual crystal-ball adventure.  But predict I did and those predictions are below or by clicking here: 2009 Wealth-ed Predictions.  This will be the ninth year I have made my annual predictions;  the first time in December 2001.   In December 2002 I made a call for the 2003 market to begin a great run starting in March.  I hit that one out of the park and expect to do the same this year.  Looking back at my early 2009 post on the direction of the market, I did prognosticate quite a bit of the year’s direction and events correctly with only a few minor errors in timing or magnitude, not direction.

• Government backed interest rates (mortgages and Treasuries) will stay low throughout 2009 (less than 1% for 2 year bonds); but sometime thereafter, maybe early 2010, they will start rising and continue going up as inflation heats up along with an economic recovery. Right – the commitment to easy money by the Fed pushes the normalization of interest rates out to mid to late 2010 now; I never imagined Bernanke would stay this aggressive this long, but am glad he has; 
• By July 2009, the high yield and corporate bond interest rates will begin to decline, narrowing the historic spread against risk free Treasuries; Right – this was my best call in early 2009; the Junk-to-Treasury spread peaked at over 2000 basis points (20%), historic highs; I loaded up on high yield debt (via FAHDX) in March and it returned 70% from there before I began getting out of the fund in October.
• Crude oil will continue weak throughout 2009 in a range of $25 -$60 per barrel; as a result production and exploration will be reduced and lower production with higher demand will set the stage for a rebound to over $100 sometime in 2010 or 2011; enjoy low gasoline prices while you can; Right – on the downside but not on the upside; and right on the general weakness in demand and its impact on supply, which has really dropped (as indicated by active drilling rig count); the peak price  ($83) exceeded my expectations because of excess monetary liquidity created by the Fed that sought out risky assets; still I benefited from this rebound as oil/gas producers via the Canroys, remain one of my largest positions;
• Gold prices will stay under $1000 in 2009, but will not decline under $600; but gold could increase to over $1500 by 2012 because of a weaker dollar caused by inflation from excess money supply created in 2009; Wrong - but for reason of timing as the Fed has been much more successful in creating monetary stimulus than I thought they would; but it is a good thing that there is excess stimulus, some of which ends up in risk assets like gold,; the spike in gold prices also mistakenly anticipates hyperinflation; If the Fed can withdraw stimulus in a timely way in late 2010, they can avoid high inflation, which will stop the gold spike below $1500. (and if they are unsuccessful, the spike can proceed to $3000 the next few years)
• In early 2009, GM will be forced to declare bankruptcy (or an equivalent government reorganization); same for Chrysler; this will set the stage for a revamping of the American auto industry and will usher in a new era of manufacturing competitiveness; Ford will escape bankruptcy, but will benefit from the changed labor and franchise rules; Right – but I didn’t think Obama would be as brash as he was in protecting the unions at the expense of bondholders, including individuals and retirees; but given his constituency, I was not too surprised at who he chose to favor;
• At least five major mall retail brands will declare bankruptcy and will be closed; candidates: Abercrombie, Zumiez, GAP, Hot Topic, Lane Bryant, Foot Locker, Eddie Bauer, Ann Taylor; but look for the retail sector to outperform as soon as 2010; Wrong and Right - wrong for good reason that the Fed was more successful stimulating the economy than I thought possible; but the names above are all in deep trouble and would have gone down if not for the Fed actions; support to consumer spending has unexpectedly helped GGP (see next); Right: Eddie Bauer went bankrupt in June, Ann Taylor closed half its stores, Lane Bryant and Foot Locker closed many of their stores, just avoiding bankruptcy;  but the retail sector did better than expected at year end as stimulus got consumers spending again (RTH +17.8% for 2009)
• General Growth may become a victim both due to the above store closings / bankruptcies, but also due to the debt it took on to acquire Rouse Companies; its survival depends on selling several of the Rouse flagship properties: Fanueil Hall (Boston), Harborplace (Baltimore) South Street Seaport (NYC) and its Las Vegas malls (Forum Shoppes, Fashion Mall, Highland Mall); Wrong – but I figured out I was wrong in April and bought GGP at that time instead at $0.65 / share; the key to investing is to stay nimble;  now it looks as though GGP won’t have to sell any properties as it exits bankruptcy; I closed my GGP out at $6.60 in early December;
• Official unemployment will top 8%, but will not top 10%; Wrong – even the “official” number could not be kept under 10%, though it probably will not go any higher than 10.5%
• Mortgage rates for 30 year fixed rate Fannies will be less than 4.5% with no points; but these rates will rise in 2010; Right – though credit is so tight that few people can qualify for the record low interest rates; look for mortgage rates to rise once unemployment declines for 3 straight months and as the govt pushes banks to start lending again;
• The stock markets will see a range and return by year end of DJI: 7000 – 10,500 (13%); S&P500;: 725 – 1100 (15%); NASDAQ100: 1400 – 2200 (10%); with the lower end of the range reached in the first half of the year (there will be a retest of the November low, but that retest will be the bottom of a new 20 year secular Bull market, albeit the new Bull will be sleepy for several years while the economy and debt are repaired);  Right – in fact, one of my best calls as I was two months earlier than Doug Kass on my market recovery prediction; I did not forecast the “panic bottom” in early March, but that lasted for only three weeks; I nailed the DOW as it ended up 13.5% for the year; SP500 was up 19% and NDQ100 was up 42.6% (my prediction was 2200 and it is 2210 today)
• The best asset class return in 2009 will be in high yield bonds (junk) with a 30% total return; Right by a landslide; and the returns were quite a bit better if catching the bottom in March as I did (+70% from January, but +90% from March);
• The 2nd best asset class return in 2009 will be in energy stocks, both producers and equipment providers, though producers will have the best total return at 25%; Right – sort of; a close call between Technology (+60%) and Materials (+48%) / Energy (+30%); I lump energy and materials together because they trade in a similar way; they all did well for the same reason, the weak dollar and easy money chasing risk assets (and foreign markets);  my idea of energy for investment are Canroys which did much better than the big integrateds like Exxon that make up the indexes; PWE which I own in a big way, is up 76.8% for the year, dividends reinvested; PVX is up 71.2% and PGH is up 41.1%
• The worst asset class in 2009 will be Treasuries with 30 year bonds returning a negative 20%;  Right – the TLT, which is a basket of Treasuries with an average maturity of 20 years, is down (-24.79%) as of today (December 25) and 30 year is worse;  this trend should continue in 2010 and longer term Treasuries should again be a poorinvestment with net losses over the year; long TBT in 2010 is a good way to take advantage of this future trend;

A response to a post by my good blog friend, Nirav:

Nirav, this is the problem with professors having opinions. Some people may want to think those opinions are more meaningful or well-informed because a given professor happens to be employed by a school like Stanford, or NYU (Roubini). But, such professors opinions about the future are no better than yours or mine. Professors should teach, and not opine.

The first thing wrong with Taylor’s opinion is his lack of command of basic financial math. A 100% change in nominal GDP over 10 years (and the resultant 50% cut in debt to GNP ratio) does not require a 10% annual inflation, but a 7.2% inflation, according to the Rule of 72, something any college finance or economics professor should know. I fully expect a 6-7% inflation within 2 years and think the Fed and Treasury are actually trying to orchestrate that.

The second thing wrong with the Professor’s opinion is the statement that a “permanent 60% tax increase would be required” to balance the budget. That statement is inconsistent with the 10% inflation conclusion. I think taxes could be left unchanged, or only increased to the degree Obama proposes, along with spending decreases, and inflation will do the rest. Not only will inflation cheapen the debt over time, it also will increase the number of dollars in which the debt is paid off. Anyone who owned a home in the 1970s remembers what a good deal inflation was at that time, so long as the mortgage was fixed. You could buy a $40K home, watch it appreciate to $80K with inflation, but pay off the debt as though it were still $40K. To the degree the Feds fix our interest costs (by issuing 30 year bonds which they should be doing in a big way right now), we will all benefit from the repayment in debt with ever cheaper dollars.

Inflation is the only way out of this box. I think the 1970s scenario is not only likely to occur, but welcome. It helped us resolve our Johnson era “guns and butter” Great Society debt of the 1960s, which in its time, was every bit as problematic as where we are today.

I would go on to say that as a responsible investor, it is important to try and anticipate the future, and not wait for it to run you over.  If inflation is in our future, as I think it most surely is, then a prudent investment strategy will take that into account.  The way to not only beat, but prosper from inflation is to own hard (real) assets, or stocks thereof. 

Oil, natural gas, industrial metals, precious metals, timberland, ag commodities, all the equipment suppliers to those industries (Joy Global, Deere, Cat, Monsanto, Nabors, Transocean, Dow Chemical, Dupont), and even real estate or REITs in the near future (once RE stops deflating) will all benefit from a long period of moderate inflation.  The Fed has demonstrated in the past its ability to prevent hyper-inflation, so that should not be a great worry.  Ben Bernanke knows the economics playbook very well.  So, rather than nashing teeth over the course of easy money and tax deficits, instead, put those actions to your own advantage.

Here is his post:

How to Reduce a Trillion Dollar Deficit

Doug Kass has a terrific track record of predicting the tops and bottoms of recent markets.  He has been known as a short seller the past several years as he thought the market over-valued.  Now, however, he has picked March 5, 2009 as the bottom and has gone long.  He was nearly alone in his convictions on that date, but has recently been joined by more and more investors, including yours truly.  Why does Kass think we have reached the bottom of this Bear?  Read on for more:

http://www.seabreezepartners.net/newsArticle.asp?id=449

March 24, 2009

Why the Bears Are Wrong
By Doug Kass, The Edge

I continue to believe that the early March low represented a yearly and, quite possibly, a generational market bottom.

The mustard seeds for the economy and the U.S. stock market have begun to take root.  The rate of change in 10 of 12 factors in my watch list are improving.

On Feb. 17, I presented a watch list of conditions that, if in an improving trend, would likely indicate that a sustainable up move is possible for equities.

It is time to review this checklist (and add one more factor) to determine the market’s standing. Our new grades and those of two weeks ago are in parentheses and will be updated in the weeks and months ahead.

1. 1. Bank balance sheets must be recapitalized. Yesterday a comprehensive bank rescue package was introduced. It is obviously too early to consider its full impact, but the details of the program suggest to this observer that it will likely be effective in clearing toxic bank assets. (We grade the package a B+, up from a D+ only two weeks ago.)
   2. Bank lending must be restored. While bank lending standards remain tight, my view is that yesterday’s announcement of ring-fencing toxic bank assets will almost unquestionably succeed in unclogging the transmission of credit. (Grade B, up from a c previously.)
   3. Financial stocks’ performance must improve. Financial stocks have finally awakened from the dead, and the recent outsized move to the upside could foreshadow continued market strength. Historically strong relative performance in the shares of asset managers — such as Franklin Resources (BEN), T. Rowe Price (TROW) and AllianceBernstein (AB) — presage a better equity market, and Monday’s strong group action was conspicuous in its outperformance. (Grade B+, up from a D.)
   4. Commodity prices must rise as a confirmation of worldwide economic growth. Beginning two weeks ago, commodities’ prices began to strengthen, and the Fed’s message last week accelerated that trend. Gold, copper (at the highest level since November) and crude oil (over $54 a barrel) continued to rise yesterday, reflecting a combination of continuing inflationary and currency debasement fears coupled with the possibility that worldwide economic growth might stabilize sooner than later. Finally, the TIPS market is forecasting some higher inflation, and a little inflation is better than a lot of deflation. (Grade B, up from a C+.)
   5. Credit spreads and credit availability must improve. Spreads remain worrisome and the transmission of credit remains poor, but the economy should gain traction as public policy is implemented, money is made more available and lending terms are liberalized. (Grade D, flat from two weeks ago).
   6. We need evidence of a bottom in the economy, housing markets and housing prices. As I have written, the retail industry has exhibited evidence of sequential improvement in the January through March period. Other economic signs are somewhat more ambiguous but, nevertheless, are showing some life. Months of inventory of unsold homes are declining and so are mortgage rates, but home prices have yet to stabilize despite an improvement in the affordability indices and a better relationship between home ownership and rental costs. Nevertheless, yesterday’s strong existing homes sales release raises the specter of a better spring selling season than most anticipate. I contend that housing could surprise to the upside and might lead most other economic indicators higher. (Grade C+, up from a C-.)
   7. We need evidence of more favorable reactions to disappointing earnings and weak guidance. I am encouraged by the better price action in the face of poor earnings results and guidance in a wide range of companies, including Freeport-McMoRan Copper & Gold (FCX), FedEx (FDX), Airgas (ARG) and General Electric (GE). (Grade B+, up from a C+.)
   8. Emerging markets must improve. China’s economy (PMI and retail sales) and the performance of its year-to-date stock market have turned decidedly more constructive, but other emerging markets remain moribund. (Grade B up from a C.)
   9. Market volatility must decline. The world’s stock markets remain more volatile than a Mexican jumping bean. (Grade C+, flat with two weeks ago.)
   10. Hedge fund and mutual fund redemptions must ease. I am comfortable writing that the worst of the redemptions are behind the asset management industry. Nevertheless, the disintermediation and disarray in the hedge fund and fund of fund industries still have a ways to go. And while brokerage account liquidations appeared to have decelerated last week (coincident with rising share prices), my high net worth brokerage contacts (such as Baron Von Broker) continue to experience account closures and a panicked constituency. (Grade C, up from a D).
   11. Marginal buyers must emerge. Low invested positions at hedge funds and by individual investors no doubt fueled March’s market rise as the fear of being out has begun to replace the fear of being in. These two classes could continue to be the near-term marginal buyers fueling stocks. Corporate acquirers could also emerge as important marginal buyers, and the recent step up in merger and acquisition activity — for example, Genentech (DNA), Petro-Canada (PCZ), Schering-Plough (SGP) and Daimler (DAI) — is a concrete indicator that another important marginal buyer has surfaced. As the year progresses, a meaningful upside move awaits a broad asset allocation move of pension funds out of fixed income and into equities. (Grade B, up from a C.) To the above factors, I am adding a 12 factor in my watch list:
   12. The market’s internals must improve. I am comforted by a number of improving technical conditions that have emerged since the March low and that have continued in force over the past two weeks since the market has made program off that nadir. Indeed, the conditions of the recent low were different than others — in sentiment, volume, number of new lows and in intensity. The move from the October lows to the March lows indicated growing fear and gave way to rising cash positions and the loss of hope, but the market’s internals were improving. November’s DJIA low of 7,552 was nearly 11% below the October low of 8,451, and the March low of 6,547 was 22.5% under October’s low. While each new low was more frightening than the prior one, however, there were improving technical and sentiment signals. For example, NYSE volume at the October low expanded to 2.85 billion shares; at the November low, volume dropped to 2.23 billion shares; and at the March low, volume was only 1.56 billion shares. As well, new lows traced decreasing levels: At the October low, there were 2,900 new lows; at the November low, there were 1,515 lows; and at the March low, there were only 855 new lows on the NYSE. Moreover, the combination of last Tuesday’s 12:1 ratio of advancing stocks over declining stocks coupled with that day’s 27:1 up-to-down volume ratio has not occurred in almost 65 years. Remarkably, yesterday was the fifth 90% upside day in March, which is evidence of a broadening market.

In summary, 10 out of 12 factors (including our newest, market internals) on my watch list are in an improving mode. Though many variables are currently accorded relatively low grades and the outlook remains debatable, the delta (rate of change) in almost my entire watch list is improving and flashing a green light for the U.S. stock market.

A classical wall of worry is being reinforced by an overwhelming consensus that the recent advance was a bear market rally. Moreover, the negative “chatter,” as Jim “El Capitan” Cramer describes it, appears loosely constructed and fails to credibly argue against the salutary effect that $4 trillion of stimulus will have on the domestic economy.

Based on the 12 considerations comprising my watch list, I respectfully disagree with the prevailing negative consensus, most of whose members failed to properly analyze the cracks in the foundation of credit, in the economy and in equities two years ago. Indeed, it remains my view that the fear of further investment losses and possible investor redemptions are clouding many managers’ objectivity in assessing the markets.

In the fullness of time, public policy aimed at stimulating the economy (in general) and in housing (in particular) should bear fruit, as will the ring-fencing of toxic bank assets serve to unclog the transmission of credit.

While it is unrealistic to expect a straight up move, I am growing increasingly confident in my variant and optimistic view that the early March low was not only a yearly low but, quite possibly, a generational low.

Coming Monday, March 30:  Jeremy Grantham 1st Quarter Commentary

The jobs report came out this AM and it is not good, even very bad news. Job cuts of 533K were announced for November and October was revised up (down) to 320K from 240K; September was revised up to 403K from 284K. That is a lot of job loss the past 3 months, the worst since Q2 of 1980 when Paul Volcker shocked the economy into submission with 20% interest rates.

But those of us who follow the market daily are not too surprised by this bad employment “print”. The stock market has been crashing anticipating very bad economic news, serving its function as oracle of the economy. And some of us (me) have seen job cuts at our own place of employment based on painful forecasts for 2009. So there is a very good chance the lousy numbers are already “baked in the cake” of the stock market. Today’s (Friday’s) early stock market action certainly suggests that, as the DJI is only off by 90 as I write now, but still well above the lows from mid November.

All of the economic slowness, global recession and the resultant strength of the dollar is just hammering energy, much to the displeasure of my portfolio. But at the same time, the government policy makers around the world appear prepared to “throw the kitchen sink” at the economy to get it going again. This will mean a recovery in 2009, maybe beginning as early as Q2. As soon as the world economies recover, the demand for energy will return and drive oil prices back up, though maybe not to $150 since the hedge funds have been hit hard and leveraged speculation in the near future is unlikely. But I think we could all live with $75-80 oil which more accurately reflected the rising demand and tight supply of early 2007. Prices in that range are economically sustainable and would create a stable environment for the Canroys.

I am swallowing hard and holding on to my energy shares, knowing that there will someday be an economic recovery and when it comes, there will also be some inflation to pay for all the money pumped into the economy. Higher economic demand accompanied by mild inflation will be a good environment for commodities and energy.

Here is more on oil:

$25 Oil Could Happen Before a Return to $100
December 05, 2008
By Matthew Hougan

http://seekingalpha.com/article/109393-25-oil-could-happen-before-a-return-to-100?source=article_lb_articles

Jim Wiandt says that oil will go to $100/barrel before it hits $25/barrel. I’m not so sure.

The reason I’m confident that the Dow Jones industrial average will top 10,000 before it hits 6,000 is that stocks are a leading indicator. They anticipate recoveries, typically turning upward 6-9 months before the economy as a whole. We are already one year into the recession, so I’m guessing we are getting close to the point where stocks will turn the corner. When you add in the fact that valuations and yields are the most attractive I’ve seen in my adult investing life, the outlook for equities is quite good.

Oil, on the other hand, reflects mostly immediate, near-term supply and demand. If the economy gets worse before it gets better, stocks might see the light at the end of the tunnel, but oil won’t. It can’t. Prices will keep falling as demand deteriorates in real time and the current supply glut gets worse.
Remember, oil is expensive to store. For the most part, it won’t just sit around waiting to be used if there is a lack of demand. (Some can be stored, but not that much). It must be sold and used at whatever the current clearing price is.
And we have yet to see the magnitude of supply cutbacks in the oil market that we’ve seen in aluminum, copper and other commodities. The world is continuing to pump out millions and millions of barrels of oil.

Here are a few facts to consider:

• Oil has averaged a nominal price above $50/barrel in just three years in the history of the world: 2005 ($50.04/barrel), 2006 ($58.30/barrel) and 2007 ($64.20/barrel).
• On an inflation-adjusted basis, oil has averaged an annual price above $50/barrel for just 12 of the 62 years of the post-war era.
• The average inflation-adjusted price of oil in the post-war era is $33.65/barrel.
• Oil traded below $25/barrel as recently as 2002.

As the saying goes, “This time it’s different” are the four most-expensive words in investing. So why not $25/barrel oil?

I was amazed during the recent oil price retreat how quick people were to say that $100/barrel was the “right” price for oil. $100/barrel is off the charts historically, and completely neglects both the supply and demand impacts that high oil prices have.

To put it another way, stock prices are now trading where they were in 1997. What’s to say oil shouldn’t be trading where it was in 2002?
The truth is, I have no idea where oil prices are headed. But I don’t think it’s a gimme that they’re going back to $100/barrel. In fact, if you gave me 2-1 odds, I’d bet they hit $25/barrel first.

P.S.: One more thought about oil. Even if you strongly disagree with me and think crude oil is a screaming buy, please be careful before you buy a crude oil futures ETF like the US Oil Fund (NYSEArca: USO). Oil is in a violent contango. A fund like USO faces a 3% monthly headwind from contango right now, meaning oil prices must rise about 3% each month just to offset the losses from rolling contracts forward. Until that situation is reversed, investing in crude oil futures could be challenging… even if I’m wrong about crude oil prices.