U.S. stocks rose strongly for a second consecutive year, with the S&P 500 gaining 15.1%. Since the market’s March 2009 bottom, the S&P has risen nearly 80% as corporate profitability has generally exceeded expectations and the economy has avoided, when measured by official government statistics, a dip back into recession. Exports showed improvement and, coupled with stronger retail spending, supported fourth quarter annualized GDP growth of 3.2%.
Growth achieved a slight edge over value for the year. The consumer discretionary and industrials sectors rose more than 25%, while commodity-linked materials and energy were close behind. Strengthening global demand, as well as institutional and speculative buying, supported many commodity prices in 2010 — a trend likely to continue in 2011.
Small- and mid-sized companies substantially outperformed larger issues, as the Russell 2000 and Midcap Indices returned 26.9% and 25.5%, respectively, versus the Russell Top 200 Index’s 12.5% return. Strong relative results for smaller companies in technology, financials (due in part to REITs), and healthcare (where large pharmaceutical and health management stocks were weak) contributed to the difference. Small companies have outperformed large by 5% annualized over the past three years. And there was a growing consensus among investors that larger, high-quality companies offered compelling valuations as 2011 began.
However, it was federal government largesse—partly in the form of an announced second phase to the Fed’s quantitative easing program and not a convincing strengthening in private economic activity—that accounted for a large component of the positive mood for equities, and risk in general, as the year came to a close. In addition to the announced $600 billion in Treasury purchases by the Federal Reserve, Congress and the Obama administration agreed to sustain the “Bush era” tax structure, soothing fears of tax increases that might constrain GDP growth. Another psychological positive for the markets was the Republican victory in the House of Representatives during November, which offered prospects for reining in excessive Federal spending over coming years.
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