December was a mixed bag of performance for the major asset classes, mainly because fixed-income was weak. Foreign developed-market government bonds were particularly hard hit last month, shedding nearly 6%, as the table below shows. But that’s not necessarily a recurring offence, since a fair slice of the loss is due to a strong 4% rally in the U.S. Dollar Index, a rare jump in the buck and its biggest monthly gain since January 2009.

Meanwhile, REITs led in the winners circle for December, rising by nearly 7%. And equities the world over showed handsome gains as well. But thanks to the selling in most of the world’s bond markets, our Global Market Index (a passive mix of all the major asset classes and the benchmark for The Beta Investment Report) slipped a bit in the last month of 2009.

For last year overall, however, there was no reason to complain. As calendar year gains go, 2009’s were among the best on record. Indeed, our own GMI rose by more than 21%. Not bad for an index that requires no investing skills or portfolio decisions, other than to own everything in its market-cap weight and let it ride.
But the rebound in assets last year is almost certainly elevating expectations that can’t be sustained. The year ahead will be tougher for the bulls, starting with the headwinds that await bonds. The combination of expanding supply as government borrowing explodes plus the potential for rising interest rates, if only marginally, will make it hard to keep upward momentum bubbling in fixed income in 2010. The one exception is if the economic challenges prove more challenging than they appear from the vantage of January 4. In that case, a rush back into the safe haven of bonds is likely and so prices could rise yet again.
Therein lies the great question for 2010: Will the economic rebound build a head of steam that’s self sustaining? It’s going to a close call. The key variable may be inventories. As economist Bill Conerly explains, “The change in inventories is the greatest uncertainty regarding the timing of the recovery.” The sharp downturn in inventories last year is now in the process of reversing, which has been a boost for GDP. But this snapback can’t go on forever. The debate is over how the return to normal, or what passes for normal, unfolds in the second half of 2010.
For the moment, the inventory trend is favorable. It’s not obvious that it’ll remain so six to 12 months hence.