|You might be interested in my article, Questions for Your Financial Advisor, below.
In This Issue…
The markets seem to be at a turning point, however, it is unclear whether they are about to turn up or turn down, so this is a time to reduce risk and wait for the market to tell us what it is going to do.
Recent market action could be interpreted just about any way you want. It looks like the market has topped out, but, it has not decisively broken down yet, either. Both the charts and graphs I used extensively and the fundamental economic picture both look negative, but they are not so bad that a little positive news couldn’t change things quickly.
It is easy to focus on all the negatives in the market and the economy and be distracted by all the “noise” created in the financial media, but there are only two things that really matter in investing. Forget earnings, politics, or the price of oil. The only things that really matter in the end are, 1) How much money is out there, and 2) How willing people are to invest it?
So, as bad as things sound in the news, never take your eye off of the ball which is the amount of money available to be invested. The Fed is still pumping money into the system in record amounts. There is a LOT of money available. Much of it is getting drained off to pay down huge debts, but with all the cash available all it takes is a small amount of interest in investments to have a large impact on the financial markets.
As a result, just as wise investors should not take a lot of risk in the face of a potential market top that may be forming, now is not the time to get overly cautious because there is still a ton of rocket fuel out there to move the market higher.
Many investors regret missing the great run-up in prices from the March 9th low and the next time the market turns up they will be quicker to get in. Likewise, we don’t want to have our feet stuck in the sand and risk missing the market’s next move. This is why I always recommend only using investments that can be turned into cash on short notice, without penalty. Nimbleness and flexibility is a key in these kinds of markets.
Regular readers know that shorting is investing that profits when the market goes down. An old adage says to “never short a dull market”, meaning dull markets often take off quickly. Between May 1st and July 10th the market has moved up and down within a relatively narrow range but overall has changed less than 1% in that time. That is boring. Compared to last fall when we had 10% moves in single days it is very boring. And trading volume has dropped to near record lows. It won’t take much buying or selling to make the market move when so few people are participating.
Successful investors are patient investors. Right now, it is time to be cautious and patient while remaining ready for change. It is not yet time to be fully invested or short the market. One thing we do know for sure is that things will change. We just need to be ready for that change with as much of our capital intact as possible.
The Riddle of the Week
What can go up and down stairs without moving?
(See answer below)
This newsletter is quickly becoming a sensation, with new readers subscribing each week. The total number of subscribers to Money Matters is now many times the size of my client base. Thank you for your interest and support, but I sometimes wonder why every reader is not my client?
Actually, I do know. Often there may be a long time relationship with a current adviser that you are comfortable with, despite disappointing performance. Those relationships have value. I understand that. More often, simple inertia keeps things as they are. Moving accounts seems like a nasty chore that most of us would just as soon ignore, hoping it goes away.
Perhaps the most frequent reason for not changing advisers when you are dissatisfied is that deep down we all are optimists. We hope the worst is over and things will soon be back to normal. If this sounds like you, be sure you consider these questions about your financial adviser.
Does your adviser ever suggest buying more of something when it goes down in price? “If you liked it at $20, you ought to love it at $10” is the rationale. The problem with this strategy is that you are buying a loser. For whatever reason you and your adviser thought it was a good investment at $20, you were wrong. Admit the error, move on, and find something else to own that is going up in price.
Have you been advised to wait until you “get back to even” to avoid taking a loss before moving to other investments? The fact is that the loss has already happened. You own today’s current value, not what you paid for the investment. The real question should be “is this the best place for my money in today’s investment climate?” If you are not sure, call me at 778-4000 to do an analysis on your current holdings.
If your advisor practices buy-and-hold, “hope” and “rebalancing” is the backbone of his investment process. The problem with rebalancing is that you are systematically cutting your winners short and buying losers. There are a lot of ways to rationalize rebalancing, but the bottom line is that successful investors own more of what is going up and less of what is going down, not the other way around.
Did I mention that hope is a four-letter word when it comes to investing?
And most importantly, be sure to ask your adviser what their plan is for dealing with the bear market if it continues. How will he/she manage your portfolio if this recession continues, God forbid, for another five or ten years? No one likes to think about that happening, but it IS a possibility. How will your adviser deal with it?
If you’re not sure about your adviser’s performance, take a look at your account statements for the last five or six quarters. What did your investment advisor actually do for you during the crash last year? What did he/she do to protect your assets?
The harsh light of these questions can tell you if you have an adviser who is just a salesperson or one who can really add value in tough times. Sadly many advisers are great talkers, but are clueless about protecting money in tough times.
Successful investing is not a one-decision process, it never has been. Sitting back and doing nothing while markets change is not a plan-it is the lack of a plan no matter what it is called! If your advisor is not doing something to earn his/her fee or commissions, it might be time for you to move on. You can’t undo the past, but you can certainly do something about your future. Investing is a life-long journey.
If you would like a second opinion on how an actively managed portfolio might improve your situation, call the office at 778-4000 to compare your results to my actively managed portfolios. There is no charge for initial consultations.
The Riddle Answer
To accomplish this, we own investments that have been performing better than the US stock indexes recently including China, international growth, utilities, health care, pharmaceuticals and high yield bonds. I have balanced those long holdings off with a short position, an inverse S&P 500** investment, one designed to go up if the S&P 500** goes down.
If the market breaks down, I will just sell off the investments we hold “long”, progressively moving to a more short portfolio that is designed to make money in a prolonged market decline. If the market takes off to the upside, I will close out the short position so it won’t dampen the ride up. It’s really a simple process that just needs regular care and feeding.
Our Flexible Income model* remains fully invested in high yield bond funds. High yields have cooled off recently, but not enough to warrant selling them yet.
There is nothing in the world that has no risk. The FDIC might have you believe otherwise, but there is greater and greater risk and the FDIC may be adding to it these days.
I am very troubled by the proliferation of FDIC insured high-risk investments. Banks traditionally re-invested your CD money in their own loan portfolios. These were usually hands-on loans that the individual bank made and then kept “in their portfolio”. Because borrowers were usually local homeowners and businesses, bankers could easily keep tabs on the quality of the investment they had made in that loan.
Banks have gotten away from this small town idea of bank lending, and are now dabbling in currency accounts, complex “structured products” that are derivative based, and accounts that guarantee you a part of the stock market’s return, all with no risk to your principal – compliments of FDIC’s backing.
Is that what you want your tax money going for? Covering someone else’s risky investment? And make no mistake about it, it is your tax money that is on the line backing up FDIC.
With any penalty for losing money removed by the FDIC, the banker’s motivation moves from making good loans to safeguard your CD to opening as many of these “riskless” (for them) accounts as they can, usually by offering higher and higher potential returns – often much higher than those offered on traditional CDs. And many investors join in with an attitude of “Why not. It’s FDIC insured” with no real understanding of what they are investing in.
Last fall during the financial crisis every major brokerage firm that also created new investment products – investment bankers in industry lingo – quickly filed to be regulated as commercial banks. Ostensibly this was to get access to TARP funds, but they are also now eligible for FDIC backing, too.
Transferring risk to a government entity does not eliminate it, but merely masks it beneath the laws of large numbers, shifting the costs to conservative investors who don’t normally lose money. Even the government cannot protect you from all risks. In trying to do so it puts its own survival on the line because the markets are bigger than the government.
Cathy and I just returned from spending a few days in Monument Valley about 5 hours northeast of Prescott. Normally the Painted Desert is beautiful with lots of orange, pinks, grays, reds and pastel greens, but the summer rains have added green foliage that really makes the drive spectacular. We took the motorhome, but there are also two very nice resorts in the area if you drive up. If you eat at Goulding’s resort, I recommend the New York steak with green chile sauce on Navajo fry bread. It was wonderful and I had never had anything like it anywhere. Be sure to take a tour of Monument Valley, the guides pointed out things we would have surely missed by ourselves and your car won’t get full of that fine red-rock dust.
Our Son, Matt is off on his first tour with his rock band, Partners in 818, playing in the San Diego area this weekend. Cathy’s sister and niece dropped in on one gig, and report that Matt puts on quite a show with his drumming. We have a demo of his work in the office if you’d like to hear what he can do. Spoken like a proud papa, huh?
July 14, 2009
William T. Hepburn
A nationally recognized authority on investment management.
Fall classes will be posted as soon as the dates are finalized.
Here’s one of Will’s articles that has proven popular over the years.
One predictable result of a down market is a rash of articles extolling investors to stay fully invested and not to try to time the market because they are doomed to failure. After all, runs the most common theme…What if you miss some of those very good days because you are out of the market? Of course, your returns would be greatly diminished.
This is the story line pushed by Wall Street institutions who have a vested interest in keeping investors fully invested at all times, but we suspected there was much more to this story that keeps getting repeated.
To set the record straight, we studied the daily return of the S&P 500* stock index for 20 years ending December 31, 2003 (5,045 market days), and discovered some startling results. The average annual rate of return for this period was 10.01%.
Missing just the 10 best days during that period dropped an investor’s average annual return to only 7.10%. Miss the 20 best days and you make only 5.03% per year. Miss only the 40 best out of 5,045 days and your annual return drops to a measly 1.60%. You might as well have buried your money in the back yard.
One might even buy this stay-invested argument until you look at the other side of the coin. What happens if an investor misses the worst days? Now the potential payoff of moving your money shines as performance soars.
Miss just the worst 10 days during the 20 years and your return rose to an admirable 14.52%. Miss the 20 worst and you would have made a handsome return of 16.86% per year on average. Miss the 40 worst days and your average return jumps to an eye-popping 20.69 % per year.
Actually, both arguments have very little statistical validity. The chances of missing only the best or only the worst days of the market are remote, because best and worst days sometimes occur back-to-back. If you miss one, you’ll probably also miss the other. So the question really should be, what happens if you miss both the best and the worst days? The data shows that an investor would actually exceed buy-and-hold performance and achieve a relatively stable return of around 11.5% per year whether just the best and worst 10, 20, 30, or 40 days were missed Part of the reason that missing both best and worst days equally boosts performance is that the worst days tend to go down further than the best days go up. Plus, there’s the mathematics of gains and losses. If you lose 20% you have to achieve a 25% gain to break even. A 50% loss requires a 100% gain to return to breakeven. If you tally up the bad days for the S&P 500 over the past 20 years, cumulative losses from just the 10 worst days add up to 76.02%. Recouping those losses would take a 317% gain, and that’s just to break even.
Making these statistics even more interesting is the historical pattern of best and worst days. Genuinely bad days in the market rarely happen in isolation. There is typically a pattern of nervousness in the market, a series of small losses that may accelerate until suddenly investors as a whole turn skittish, pushing the market down to a bigger loss. As we stated earlier, often the best one-day returns occur shortly after a major decline.
Wall Street’s propaganda machine would have investors stay fully invested through thick and thin. After all, Wall Street makes money when they have your money to work with. This study suggests that risk may be reduced and returns boosted by strategic retreats from the market.
We only send to people who have personally requested a subscription through contact with staff, or who opted-in at our website, http://www.HepburnCapital.com. Please call us at 928-778-4000 if you have any questions.
* The model accounts mentioned in this article are hypothetical examples of how the strategy may work as designed. Activity in client accounts may be different from that in the model in amount of each investment, specific timing of trades, and actual security used, which may vary from account to account. Not all trades are profitable. It should not be assumed that current or future holdings will be profitable. A list of all trades in these accounts for the past 12 months will be provided upon written request.
** The S&P 500 and Nasdaq Indexes are unmanaged lists of stocks considered representative of the broad stock market. Investors cannot invest directly in the S&P 500 Index.
Information in this newsletter is derived from sources deemed to be reliable, however we cannot guarantee its accuracy. Please discuss any legal or tax matters with your advisors in those areas. Neither the information presented nor any opinions expressed herein constitute a solicitation for the purchase or sale of any security.
Click here to contact us. In all investing, past performance cannot assure future results, and as such, our efforts are not guaranteed. Losses can occur. All strategies offered by Hepburn Capital Management, LLC, adapt to changes in the markets by changing the investments they hold. Therefore, comparisons to broad stock market indexes such as the unmanaged indexes listed above may not be appropriate. Sometimes client accounts are invested in stocks or markets not included in these indexes. Past performance does not guarantee future results. Investment return and principal value will vary so that when redeemed, an investor’s account values may be worth more or less than when purchased. Mutual fund shares are not insured by the FDIC or any other agency, are not guaranteed by any financial institution, are not obligations of any financial institution, and involve investment risk, including possible loss of principal. Advisory services offered through Hepburn Capital Management, LLC, a Registered Investment Advisor. HCM will not transact business unless properly registered and licensed in the potential client’s state of residence.
Copyright (C) 2009 William T. Hepburn. All rights reserved.