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4.15.2009 2009 1st Quarter Newsletter
Economic Update: Light at the end of the tunnel?
During the first quarter of 2009, the nation’s unemployment rate rose to 8.1% and the housing market remains in a nosedive decline. Through January, home prices have fallen 29% from their July 2006 highs (Case-Shiller Index).
As the various liquidity injections by governments take hold and banks provide more credit to businesses and individuals, we continue to look for a modest economic recovery by early 2010. Modest! The recovery will be weaker than the capital markets will anticipate.
Market Update: Still higher in 2009
We continue to believe the stock market in 2009 will be positive, although the journey will be volatile. Thus far, volatility has ruled the day.
The bear market rally we talked about in our last newsletter turned out to be an unsustainable 24% rally from the November 20, 2008 lows to January 6, 2009. The S&P 500 proceeded to lose 27.6% of its value from January 6 through March 9 when new bear-market lows were reached for all the major indexes. From the March 9 lows through March 31, the market headed higher and has logged an 18% gain. After all that, for the first quarter of 2009, the S&P 500 was down 11.7%.
Market volatility will continue due to a wide variety of factors including government policies to address banking woes & mortgage refinancing, corporate profits (losses), corporate “surprises” (bankruptcies, acquisitions), European responses to the same issues and the resilience of emerging market economies, among others.
The equity markets will be higher a year from now, because (a) confidence in the credit markets is slowly reappearing and financial institutions are beginning to lend again, (b) there are large amounts of cash on the sidelines willing to buy equities, and (c) the perception of an economic recovery. When the holders of such cash decide to resume taking market risk, the impetus to stocks may be swift and strong.
Equity markets are now priced to return 10 to 13% per year on average over the next 7 years (GMO). We expect that these returns will be skewed higher at the front and back-end of the 7-year period.
Portfolio Update: Strategic investing will prosper
One of the more important lessons learned over the past 18 months is traditional “buy-and-hold” asset allocation is not working. Both good and bad investments are moving in tandem with very few exceptions. Even fixed income has been highly correlated with stocks.
Our portfolio out-performance of the markets over the last 18 months has been due to our decisions to reduce market exposure when risk was high and increase market exposure when we perceived risk to be lower. In hindsight, we should have done more of this.
Our primary objective when managing your money is to preserve your capital. Our next priority is to grow your capital. Toward those ends, until this market completes this bear cycle, you will notice increased activity in your accounts to preserve capital. When we perceive market risk to be high, we will sell or “hedge” market risk. When our research indicates the markets will move higher and the market opportunities are likely to be potentially rewarding, we will be opportunistic and purchase investments. Additional insight into this approach to navigate these volatile markets is detailed in an attachment titled: A Paradigm Shift. I thank you for your continued trust and support.
Trevor K. Holsinger, CFP
A Paradigm Shift
There is an oft-repeated slogan associated with many financial recommendations: “Past performance does not ensure future success”. This statement has never been more accurate than during the current decade. During the last bull market (1982-2000) the popularized “buy-and-hold” investment philosophy became standard operating procedure. Most financial advisory firms and investment companies (Fidelity, Vanguard) made this their philosophical mantra.
“Buy-and-hold” worked great in the 1980s and 1990s. Since 2000, “buy-and-hold” has not worked! Selective asset classes have performed better than US equities, the primary “buy-and-hold” asset class. Navigating the capital markets this decade has required owning some asset classes and avoiding other assets classes entirely.
Over the last year, we have been striving to develop a more tactical asset allocation approach to investing. In addition to our fundamental research, we are applying global macroeconomic drivers and market technical analysis to our investment decision-making. The goal is to minimize, if not avoid, significant investment losses by preserving capital for deployment to attractive opportunities when they present themselves. Had we employed this approach to its fullest, we believe the slightly negative returns for first quarter 2009 would have been positive. Rather than utilizing “buy-and-hold” or asset-class selection and always having capital at-risk, we are engaging an approach that we believe is a safer and a more productive course in today’s volatile investing climate.
Buy-and-hold, asset class selection, and risk-managed philosophies are described below in more detail.
Buy-and-Hold
The traditional “buy-and-hold” investment strategy says to take risk at all times. Buy-and-hold is a long term investment strategy based on the view that in the long run financial markets give a good rate of return despite periods of volatility or decline. This viewpoint also holds that market timing, i.e. the concept that one can enter the market on the lows and sell on the highs, does not work for small investors so it is better to simply buy and hold. My interpretation is small investors are losing significant amounts of money in the current bear market environment, but if they survive, the market will reward them over 20 plus year timeframes. Not only has this philosophy not worked for the last nine years, it has lost money.
This philosophy does not believe in asset class selection. It is rooted in the belief that markets are efficient and you can not identify which stock, bond, or asset class will perform better than another. In general, buy-and-hold believes in owning all assets classes regardless of price including: US large and small company stocks, international stocks, emerging market stocks, government bonds, corporate bonds, commodities, and cash. However, since the end of the last bull market in August of 2000, “buy-and-hold” has lost money.
Asset Class Selection
An investment approach that did work well between August 2000 and October 2007 was “Asset Class Selection”. This entails owning more of the undervalued asset classes and less or none of the over valued asset classes. Aspen Wealth Management outperformed the markets during this time by owning very little US large companies and owning more US small companies, international small companies, and emerging stocks and bonds. This strategy of over-weighting undervalued asset classes has outperformed traditional “buy-and-hold” during this decade. From January 2000 – October 2007, here are the annualized returns of some of the more well know asset classes:
January 2000 – October 2007:
| Index |
Annual return |
Total return |
| Emerging Markets: |
16.7% |
235% |
| International Small Cap: |
13.9% |
176% |
| Russell 2000 (US small cap): |
7.9% |
81% |
| International Large Cap: |
6.5% |
64% |
| S&P500 (US large cap): |
2.3% |
20% |
Emerging markets and international small cap significantly outperformed US large and international large. We identified these opportunities early in the decade. Opportunities for specific asset classes to out perform significantly do not exist today.
Risk-Managed Allocation
During the last year and a half, the shortcomings of “buy-and-hold” and “asset-class-selection,” have been exposed. Equities around the globe are lower, corporate bonds are lower, and commodities are lower. The severe bear market correction has caused almost all asset classes to decline significantly. Survival in this environment has required the identification of when to take risk and when to not take risk. It doesn’t matter where the risk is taken. Taking risk in any risk-based asset class has punished investors.
Bull markets act as rising tides in which all asset classes rise. However, the recent eighteen month bear market has spared few asset classes. As opposed to the rising tide phenomenon, what we have experienced is more akin to bath water spiraling down the drain.
Bear markets begin with an initial, large correction or two, and then often a move “sideways” for years during which there is significant volatility. In these bear and sideways markets, “buy-and-hold” and “asset class selection” will not do well in terms of positive investment returns.
S&P 500 Performance from Oct 9, 2007 through Mar 31, 2009
| From |
To |
Gain/Loss % |
Buy/Hold Cumulative |
| 10/9/2007 |
1/22/2008 |
-16% |
-16% |
| 1/22/2008 |
5/19/2008 |
+9% |
-8% |
| 5/19/2008 |
7/15/2008 |
-15% |
-22% |
| 7/15/2008 |
8/28/2008 |
+7% |
-17% |
| 8/28/2008 |
10/10/2008 |
-31% |
-42% |
| 10/10/2008 |
11/4/2008 |
+12% |
-36% |
| 11/4/2008 |
11/20/2008 |
-25% |
-52% |
| 11/20/2008 |
1/6/2009 |
+24% |
-40% |
| 1/6/2009 |
3/9/2009 |
-27% |
-56% |
| 3/9/2009 |
3/31/2009 |
+17% |
-49% |
As you can see from the table above, the ups and downs in the stock market over the last eighteen months have been numerous and significant. The market has advanced or declined more than 10% eight times. We anticipate more of the same for the foreseeable future.
We have adapted our investment strategy to better suit this volatile environment. We strive to avoid the periods of significant decline and participate in the rallies as much as possible. When our indicators suggest that market risk is high, we will reduce, hedge or eliminate our investment positions; when research suggests that market opportunities are reasonable, we will increase investments. Our goal is to preserve capital and put it to work when positive returns are most probable.
We believe a Risk-Managed Allocation philosophy will provide market beating returns, if not positive returns until such time it makes sense to return to “buy-and-hold”. The time to switch back to a “buy-and-hold” philosophy will be identified by the S&P500 reaching a multi-decade low in the 500s in the next 3-5 years.
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