2009 will leave its mark burned into market history. It was a year of extremes. There were extreme risks, extreme rewards and plenty of opinions. Listening to the news made it feel like the world was ending. In reality, plunging prices created a huge opportunity. Some believe the government saved us from apocalypse, and others argue that the government made the long-term situation worse. Political views were more polarized than ever with two dramatically different views on what  living in America should look like. Free markets and capitalism were attacked like never before.

The net result for the stock market was a major roller coaster ride. After the collapse in the global financial markets, the market was pummeled throughout the second half of 2008. No one predicted the decline or its magnitude. The consensus at the end of 2008 was the damage from the housing bubble had been contained. Most forecasters were not even sure we had entered into a recession.

In January the consensus was hopeful again. They said the worst of the market decline was behind us. By March, the market dropped again providing the consenus wrong..

About that same time, the consensus shiften to extreme fear with respected economists and market gurus forecasting further declines and even another Great Depression. The fear indexes we track registered twice as hight as they had ever registered. To help calm concerns, we put together a presentation that refuted the rhetorical question, "Is the world ending?"

About the time everyone was completely scared to death and market forecasts were the direst -- the market turned positive. From the market bottom on March 9th, global markets rallied about 60% through year-end. This time, the market wreaked havoc by going up, just after record numbers of panicked investors sold their positions.

Investors were rewarded who had a good investment strategy in place and followed it. Investors who did not have a good strategy and/or did not follow their strategy were severely beaten up... once again.

PARAGON PORTFOLIOS

Our portfolios continued to outperform in 2009. Our conservative portfoilo, Managed Income, gained 16.0% compared to 5.9% for its benchmarket, the Barclays Bond Index. Our growth portfolio, Top Flight, gained 34.6% versus 26.45% for its benchmark, the S&P 500. (See track record and full disclosures on our website)

The volatility in 2009 was extreme. The Dow Industrials lost 53.8% of its value from its high in October 2007 to its March 2009 low. It gained 59.3% by year-end, its fastest climb since 1933. As always, some sectors lagged while others outperformed. In general, those that went down the hardest also came back the fastest. For example, Emerging Markets led with the largest gains followed by Latin America. Europe was almost in line with the U.S. markets while Japan lagged. Growth strategies outperformed value and large cap stocks outperformed small cap. The falling dollar also came into play affecting some markets more than others.

Our models did a great job of keeping us on the right side of the market and focused in the right areas. Over the past 27 months, conditions have been extreme, and our models had to constantly adjust to radically different market conditions.

Initially, with the financial markets in freefall, we needed to position defensively. Having nowhere to hide made that adjustment more difficult than normal. Almost every sector was going down, hard and fast. When we hit the March bottom, once again our models made significant adjustments. Now the markets had reversed course and were moving up at the same speed they had been previously moving down. At the March lows, our models positioned us in those areas of the market that traditionally do best after a market meltdown. Over the past few months our models have moved us into those areas that do best as the economy recovers from a recession.

WHAT NEXT?

Market sentiment is an indicator we have used a lot over the years. In short, when most people think the market will go down, that is actually the time it is likely to go up. Conversely when most people think the market will go up, that is when it is most likely to go down. Coverage in the press, the internet and 24-hour news cycles further magnify the effect of sentiment.

Our sentiment models are some of the most accurate ones in our arsenal. The sentiment models prove that if you invest based on popular opinion or what you see in the press, you will likely lose money.

When we came off the March lows, almost no one believed the market was headed up. As the market moved up, about 65% over the next nine months, skeptics abounded. Every time it moved up, experts everywhere proclaimed the market was headed back down. Everything in the press was extremely negative. In other words, the market climbed a wall of worry. Consequently, as long as there is plenty of worry out there, I am not very concerned.

Once we get to the point when everyone agrees the market is going up... that is when I will be more concerned about the downside.

From a valuation perspective, I don't believe the market is overvalued yet. We look at numerous valuation models and some show the market overvalued while others show it undervalued. The valuation models I agree with most show the broad market at about 20% below fair value.

From a simplistic standpoint, the Dow was at 14,000 in 2007 and then it fell all the way to 6,500, in March 2009. From the 6,500 bottom, it has moved back up to 10,500. It is still 25% below where it was back in 2007. Even back then, most valuation measures didn't show the stock market overvalued -- they showed it at fair value.

Bottom line, I am not concerned from a valuation standpoing, but I am concerned about the increasing positive sentiment. Whether this recovery is going to be in the shape of a V, a W or a sqare root, no one knows. The truth is there are several ways this recovery could play out. We will not know until after the fact which scenario will unfold. That is why we do our best to ignore forecasts, remove emotion from the investment process and rely on our models to guide us through this.

Many investors on the sidelines has missed this entire rally. They failed to understand that the stock market is a leading indicator. While there is plenty to worry about, the market will recover long before the general economy does. Most of our models have been positive since the March lows. There seems to be a lot of momentum left int he current trends off the market bottom.

On the other hand, I think bonds are a disaster waiting to happen. With interest rates at all time lows their yield really have nowhere to go but up. When the yields do move up, bondholders will lose significant amounts. In Managed Income, we own some bonds, but are ready to sell them as soon as we see signs of increase in the interest rates. I would not "buy and hold" bonds at these levels.

At times like these, it is crucial to have your risk tolerance set properly and your portfolio aligned with your personal objectives. If you have any questions or concerns regarding your personal investment strategy, feel free to contact us. We look forward to working together in 2010.