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Stocks post another year of gains, belying investor doubts

The equity markets saw double-digit gains in 2010, for the second straight year. But there are worries that higher interest rates could rein in the bulls this year.

January 01, 2011|Tom Petruno | Market Beat

The U.S. stock market in 2010 racked up a second straight year of double-digit returns, as the economic recovery rolled on and Wall Street bet there's more to come.

But equity investors may rightly wonder if their gains last year — the average stock mutual fund was up about 17% — were adequate compensation for the mental stress they endured. Europe's debt crisis, the U.S. market's May "flash crash" and a summer economic slowdown all made for a torturous ride in stocks.

And with the Federal Reserve's renewed efforts to bolster the recovery by pumping more money into the financial system, the nagging fear is that share prices might not be up at all without continued help from Washington.

One sign of investors' deep anxiety about the future: The price of gold soared for a 10th straight year, rising nearly 30% in 2010 to end Friday at $1,421.10 an ounce, a record before adjusting for inflation.

Many Americans simply steered clear of the stock market for most of last year, as they did in 2009. While some people snapped up gold and silver coins instead, huge sums were funneled into bonds and into bank accounts that paid virtually no interest.

After the devastating crash of 2008, "The volatility of the market was just too much for many investors," said Jim Stack, a veteran money manager who heads InvesTech Research in Whitefish, Mont.

Even so, those who stayed put in stocks for the last 12 months mostly came out ahead. The Dow Jones industrial average ended Friday at 11,577.51, up fractionally for the day and up 11% for the year after an 18.8% rise in 2009.

Many broader market indexes outpaced the blue-chip Dow, as they did when the market rebounded in the previous year from the financial-system meltdown. The Standard & Poor's 500 index, a common benchmark for retirement accounts, closed Friday at 1,257.64, off slightly for the day but up 12.8% for the year.

Small-company stocks again were standouts, with the Russell 2,000 index of smaller shares surging 25.3% in 2010. Investors' willingness to take a chance on those riskier issues is considered a sign of faith in the economy.

For much of the year, though, equities struggled. After a first-quarter rally, fear of government-debt defaults in Europe triggered a global market sell-off in the first few days of May.

That set up the infamous "flash crash" on Wall Street: On May 6 computerized trading ran amok, fueling a plunge that at one point had the Dow index down almost 1,000 points for the day before prices rebounded.

That was the last straw for some people. U.S. stock mutual funds began to suffer persistent net cash outflows immediately after the flash crash as more investors yanked their money.

By early summer, the economic outlook seemed to justify shunning the market: Business activity and consumer spending slowed, and analysts began to fear that the U.S. would slide back into recession. "Double-dip" became the watch-phrase of the summer, and the Dow fell as low as 9,686 by July 2.

But even as the economy sputtered, big-name U.S. companies continued to show hefty profit growth, helped by strength in their overseas operations. That put a floor under stock prices.

And by August, Federal Reserve Chairman Ben S. Bernanke was telegraphing that the central bank might ramp up its purchases of Treasury bonds to try to suppress longer-term interest rates and channel more money into the economy.

Once the calendar turned to September, the stock market was off to the races again, even before the Fed formally kicked off its $600-billion bond-buying program Nov. 3.

Investors' confidence rose as the economy showed fresh signs of momentum in retail sales and manufacturing activity.

What's more, the Republicans' sweep in the November elections set up Congress' deal with President Obama to extend the 2001 and 2003 tax cuts that otherwise would have expired Friday. Not surprisingly, saving the tax cuts was high on Wall Street's priority list.

As 2010 ended, the stock market was on an emotional high. The Dow and other indexes this week hit their best levels in at least two years.

The year's hottest market sectors were bets on healthy economic growth: retailers, industrial companies and commodity-related firms, for example.

Shares of discount chain Target Corp. jumped 24% in 2010 after rising 40% the previous year. Timken Co., which makes ball bearings for all sorts of uses, rocketed 101% after a 21% gain the previous year. Mining firm Southern Copper Corp. rallied 48% on top of a 105% surge in 2009.

Yet even some stock market bulls wonder whether the economy can reach so-called escape velocity in 2011, meaning a level of growth that can sustain itself without the help of the Fed's extraordinarily easy-money policy and $1-trillion-plus annual federal budget deficits.

"At some point we have to get off the fiscal and monetary crutches," said Jack Ablin, who oversees $60 billion as investment chief at Harris Private Bank in Chicago.

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