Well another year is gone and it was a kick in the pants for the markets. Let’s cut to the chase:

Performance Results

2009 was a great year for stocks. The numbers below include interest and dividend total returns from Morningstar and are rounded to the nearest tenth as of 12/31/2009 (values may change a little as distributions, etc. are counted but the point is still valid):

S&P 500 +26.3%

Total Stock Market Index +28.9%

EAFE International Index +26.9%

Emerging Market Index +68.8%

Commodities Index +16.2%

Real Estate Investment Trust Index +25.5

Treasury Inflation Protected (TIPS) Bonds +10.8%

Corporate Bonds 8.6%

International Bonds 6.7%

Total Bond Market 3.3%

Now we’ll list the components of the Permanent Portfolio Allocation if you chose to build it only with Exchange Traded Funds (ETFs):

25% Vanguard Total Stock Market ETF (Ticker: VTI) +28.9%

25% iShares 1-3 Year Short Term Treasury Bond ETF (Ticker: SHY) +0.25%

25% iShares 20+ Year Long Term Treasury Bond ETF (Ticker: TLT) -21.8%

25% Gold Price appreciation for the year +24%

2008 End of Year Result: +7.8%

In Like A Lion – Stocks

January 2009 came in with the 2008 bear market still raging. By March 2009 the US Total Stock Market index sank -27% since the beginning of the year and almost -56% since the bear market started way back in October 2007. A brutal bear market by any measure and by March many people were thinking it was just going to keep going down:

Total Stock Market January to March 2009

(Chart courtesy of www.stockcharts.com)

Then, a surprise. By March of 2009 the market went on a tear upwards. A powerful recovery happened that took the losses from earlier this year away and ended up almost +29% for 2009. From the March 9th, 2009 low to December 31, 2009 the Total Stock Market went up almost +71% in value!

Total Stock Market 2009

(Chart courtesy of www.stockcharts.com)

As of now, stocks are about the same place they were at the end of September 2008. They are still about -25% below their October 2007 highs and need to go up another 33% to get back to that point. Maybe 2010 will deliver?

Total Stock Market High October 2007 to December 2009

(Chart courtesy of www.stockcharts.com)

Mr. Popularity 2008 Finds Out He Was Just Being Used for His Money – Bonds

What about our US Treasury long term bonds? They were so faithful to us in 2008 and were the only asset to really turn in a stellar performance and prevent losses to the portfolio. Well, the market panic that sent everyone into Treasuries at the end of 2008 quickly faded by January and they began to sink. I mentioned this possibility last year and urged readers to make sure they rebalanced out of bonds if needed and I hope this advice served you well.

As it were, long term bonds went down in price as interest rates recovered (bonds move opposite to interest rates, remember). Long term bonds turned in a disappointing year of around -21%. If investors bought Treasuries in January they hit the peak and took maximum losses. If you bought any time after the January price spike you took perhaps -12% at worse or nearly flat for the year at best.

iShares Treasury Long Term Bonds 20+ Years

(Chart courtesy of www.stockcharts.com)

This is what it looked like if you had just bought Treasuries one month later:

TLT From February 2009 to End of Year 2009

(Chart courtesy of www.stockcharts.com)

Is this an argument for Dollar Cost Averaging into assets? In this extreme, perhaps. But I think most of the time Dollar Cost Averaging doesn’t help too much.

One more chart on this because I thought it was interesting to support buy and hold and not jumping in and out of assets based on how hot they are in the news. If you’d have bought Treasuries in early 2008 and held on you’d be up a few percent even with the price correction early in 2009. The spike in 2008 would have been a great time to rebalance though and offset the stock losses by locking in your bond gains and using that money to rebalance into stocks which had dove in price. But even if you didn’t do this, Treasury bonds are up over 50% going back to the early 2000s just by doing nothing at all.

Long Term Treasuries from 2008 to 2009

A Boring Asset Does Something Interesting – Cash

This was an interesting year for Cash because the portfolio holds it in a Treasury Money Market Fund. Most Treasury Money Market funds ended up paying interest at effectively 0% for 2009 as panicky investors tried to avoid any type of credit risk in other funds. Large companies like Vanguard in fact closed down their Treasury Money Market funds to new investors to prevent having the fund going into a situation where yields could fall to 0% or below. In the 1930s, Treasury Bills did in fact go negative yield at one time as investors were willing to pay someone hold their money safely as banks were far too risky during the Great Depression.

Ultimately our tracking index for Treasury Bills is the iShares Short Treasury ETF (Ticker: SHV) and it shows us up +0.16%. Those that went with my modified Permanent Portfolio cash holding of a US Treasury Short Term Bond fund (Ticker: SHY)  that has slightly longer duration instead of a Treasury Money Market Fund were up around 0.25% or perhaps a little better. Still nothing to write home about. Here is the chart for the SHY ETF:

Short Term Treasuries 2009

(Chart courtesy of www.stockcharts.com)

A Shocking Performance – Gold

Finally we have gold. This asset received a troubling amount of attention this year (I get very nervous when people are talking too much about any one asset in a positive “it can’t be stopped!” kind of way). This year gold set new price highs, but not in real terms compared to the 1981 peak. In 2009 gold went to $1200 an ounce and has been comfortably settled above $1000 an ounce for the latter part of the year. In real terms, the gold price in 1981 still has it beat as inflation adjusted the price then was over $2000 an ounce. In 2009, gold was up almost as much as Stocks for a +24% gain. In fact it was up over 35% for a brief time which was far higher than stocks. I didn’t expect this type of performance from gold at all this year:

Gold Prices for 2009

(Chart courtesy of www.stockcharts.com)

Will we see gold hit $2000 in 2010 or will it fall to $300? I have no idea. It seems the markets are not settled by the Federal Reserve printing of money to bail out everything that moves. I think it’s called “Quantitative Easing” which is simply translated as: “We’re buying a bunch of stuff nobody wants with money that we don’t have.”

The Fed has in fact been easing their quantitative selves into the markets behind the scenes buying Treasuries and other assets to keep the prices at some magical point that they think the world wants. How long this game will go on nobody knows, but it will be interesting to watch it all unwind. And by “interesting” I mean you better stay diversified because nobody knows how this thing is going to play out.

Comments and Comparisons

2009 was an incredibly volatile year in the markets. In March it was still looking very bad with Stocks going on a nasty slide along with bonds. It’s easy now to look back on 2009 with those big stock gains and pat yourself on the back. But, there wasn’t much patting going on during the Winter and Spring months compounding the 2008 stock losses.

In terms of best performance it would be obvious that someone who dumped their money into all Emerging Markets cleaned house. A nearly +70% return sure would have been nice! Not likely, but nice.

A stock focused portfolio such as one split between 60% Total Stock Market and 40% Total Bond Market turned in a splendid +21% return. Overall, anything with higher stock weightings did very well this year. Is it enough to offset the losses incurred in 2008? It just depends how much the portfolio lost last year according to this handy chart:

Getting Back to Even

The last decade of the US Stock market is one of the worst on record. Pundits are calling it “The Lost Decade.” I guess it’s what sells magazines. But the reality is we’ve had “Lost Decades” in the stock market before. The 1970s for instance saw zero real returns in stocks due to inflation. That’s why this idea that holding stocks only is such a bad idea. The key is you need to be diversified and you need to rebalance to control risk. There are protracted periods where any asset can do poorly and that includes stocks. This is not to say stocks won’t have a great 10 years going forward, just that the future is unpredictable so it pays to diversify.

Sticking to the Plan Works

The past couple years in the markets have shown the value of having a diversified portfolio and sticking to your plan. I think it also showed the value of limiting volatility so investors don’t panic sell at the wrong time.

In terms of performance, some can say “Hey, the Permanent Portfolio returned only around 8% this year when stocks were up over 20%!” And I would simply say: “Yes it did. And in terms of its average returns in the 8-10% range it did just as expected and has never delivered serious losses the way stock heavy portfolios have.”

The portfolio strategy is designed not to have these wild up and down swings. So while you probably won’t be getting these huge double digit gains, you also are less likely to get huge double digit losses. The portfolio has tended to drift along in a moderate return zone with no big drama. I think drama should only be happening in the theaters, not with one’s life savings.

This is what the four asset classes looked like in total (Gold – Magenta, Stocks – Red, Cash – Green, LT Bonds – Blue) for the year:

Permanent Portfolio Total Year 2009

(Chart courtesy of www.stockcharts.com)

Investors have to look at portfolios in total and not at assets in isolation. In most years you’re going to have one or more assets that are lagging. One of them may be a real stinker in fact. But the winners can offset the losers so the portfolio will still grow. This is diversification in action.

It’s a Marathon, Not a Sprint (or insert your favorite cliche here)

By limiting volatility the Permanent Portfolio allowed investors to (hopefully) stick to the plan through these past couple years. Last year this would have meant selling down their bonds and buying stocks at a nice discount for 2009 which I advised:

By not rebalancing [bonds], you may miss out on large gains in your other assets by having too much of your money tied up in your current winners. Imagine missing out on a 20%, 30% or higher gain next year in stocks if the markets recover and things work out.

YES, I know that sounds impossible right now. But it’s happened before and YES it usually does it after a bad market crash.

Gains like I just mentioned happened after the early 1970’s recession (1975 +37%, 1976 +24%), after the recession in the early 1980’s (1982 +21%, 1983 +22%), after the early 1990’s recession (1991 +31%), after the early 2000’s Internet bust (2003 +29%) and they even happened during the 1930’s Great Depression (1933 +54%, 1935 +47%, 1936 +34%, 1938 +31%).

Now we have a situation like this that has happened in our stocks and gold. Many may find that these two assets could be near or above their rebalancing bands for the portfolio (either 30%-35% as you see fit). If this is the case, then I urge you to rebalance (taxable investors should try to maximize long term vs. short term gains if possible). That means sell your winners down to 25% and buy your losers back up to 25%.

Yes, I know that some are talking about inflation and how Long Term Bonds will get killed. Yes, I know that some are expecting stocks to go up +50% this year. Yes, I know that some see $2000 gold on the horizon. Yes, I know that some don’t like holding onto cash. Yet, some of these people are going to be right, and some of them of them are going to be wrong. I wish we knew which was going to be which, but we don’t. I encourage readers therefore to keep a balanced approach and be happy with their stable returns vs. swinging for the fences and risk striking out. Those +20-30% returns you hear people getting come with a tremendous amount of risk as 2008 demonstrated. Many people are probably still in the hole with their previous losses.

To use a cliche: “It’s a marathon, not a sprint.” That certainly is important for investors to remember. Those boring stable returns for the Permanent Portfolio will really add up over the years. And, the lower volatility helps investors keep their cool when markets are misbehaving. So rebalance that portfolio if you need to do it and ignore the market pundits. I use this portfolio allocation myself and it helps me sleep like a baby. I hope that it does the same for you and wish you all the best in 2010.

Happy New Year!

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