One of the best parts about being tactical manager in global markets is that there is no real information “edge” that our competitors can get from from their analysts or the old-school network. The edge in tactical asset allocation resides in having a repeatable research process that can quantify supply and demand, and implement decisions based on these common-sense factors.

As a practical matter, we look for the appearances of key words and phrases in mainstream media and then note them our risk management process. A few days ago, CNN Money wrote an article that was forwarded to me at least ten times by friends and family.

The title was, “2010’s coming stock market crash: 1987 all over again.”

We  love to read headlines like these. And magazine covers with similar “world-ending” news make our mouths water. If anything, the media tells us one thing: what not to do. On August 13, 1979, the cover of BusinessWeek magazine read: “The Death Of Equities.” This was literally the beginning of the biggest bull run of all time. In other words, the timing of markets is impossible, but that is what the media does to keep fear and greed afloat, readers reading, and investors making wrong decisions.

RECENT EXAMPLES

Most investors look back on 2008 and refer to it as the Financial Crisis, which indeed it certainly was. While many of the issues that have been deemed accountable for and the crisis remains unresolved, the markets moved on, evidenced by the 70% return since March 2009 for the S&P 500.

But what exactly does the media emphasize they have moved on to? Another crisis, and then another, and then … well such is the nature of markets. If its not a tech bubble, its a US Dollar bubble, or a housing bubble, or a sub-prime bubble, or a broader credit bubble, or a global economic bubble, or a Dubai bubble, or a Greece bubble, or an EU bubble.

Therefore…

We don’t wake-up every morning and read the WSJ hoping the first column gives us a signal. We wake up to a new daily set of data. Most of it is technical; some of it is fundamental and value oriented. But all of it is quantified and risk-managed.

The Pinnacle of Borrowed Money

At this stage of the Sovereign Debt Crisis (Europe behind on their bills) , it’s fascinating to observe how little professional politicians know about what they don’t know. From Athens to Albany, finding answers in Piling Debt Upon Debt Upon Debt in the billions via exchanging currencies is not going to end well. Anyone who isn’t paid to be willfully blind may understand this.

We all know that hope, unfortunately, is not a strategy. The truth of history is that debtor nations who are behind on their bills (by, uh… billions) are as hostage to their creditors as we are to our mortgage companies.

What if the Chinese or Japanese – the largest lenders to our country – imposed the threat of the US paying what we owe them? Up until Greenspan went global with the system of US economic policy, US public debt held by foreigners was less than 20%. Now it’s pushing north of 50%, and that’s the point. The Buck stops there – and don’t think for a second that America isn’t setting herself up on  to get run right over by the same oncoming train that Europe is.

This is why we call it the Sovereign Debt Crisis. There is simply a problem when Europe and America will see their debts come due. There is absolutely no irony that Greece started to unwind before Spain did. Nor will there be as Spain starts to unwind before France and the US do. The timing of a nation’s balloon payment is a big issue.

America has to roll over 40% of US Treasury debt by 2012. Even compared to a country like the UK that has already been forced to devalue its currency, that’s more than a double versus UK maturities as a percentage of the total outstanding!

Altogether, this is the #1 reason why we have sold more US stock market investments this week. The duration gap is finally starting to narrow between the Europe having their pants pulled down in front of the world and the tide rolling out on our professional US politicians.

This morning the Euro is making another lower-low, and remains broken on the technical charts we read. As a result, since 58% of the US Dollar Index is Euros, the US Dollar will most likely hit higher-highs.

Unless Ben Bernanke stops behaving badly and gets this US currency and the sovereign debt that underpins it under control, this US/European problem will keep stinging the market and investment accounts that are not closely watched.

ETF News 

• iShares launched three new country-specific ETFs last Friday, which pushed the total combined number of ETFs and ETNs available on the US market to 1001. The iShares MSCI USA Index Fund (EUSA) will be an all-cap fund seeking to measure the performance of the top 85% of U.S. securities (based upon market capitalization). The iShares MSCI Ireland Capped Investable Market Index Fund (EIRL) was also launched and is currently the only ETF offering exposure to the Irish market. EIRL is linked to the MSCI Ireland Investable Market Index, which currently consists of 21 companies with significant exposure to basic materials (25%), consumer staples (23%) and industrials (18%). The iShares MSCI Indonesia Investable Market Index Fund (EIDO) will compete directly with the Market Vectors Indonesia Index ETF (IDX). EIDO is heavily weighted in financials (28.7%), energy (13.4%), and telecommunications (13.3%) and was launched with a 0.65% expense ratio (0.03%) lower than IDX. For more information:
   
  • U.S. One Trust has launched The One Fund (ONEF), which is an actively managed “fund-of-funds” that will invest in other broad index-based ETFs, achieving both domestic and global equity exposure at a low cost to individual investors. ONEF carries a 0.51% expense ratio and is intended to be a long-term investment instrument.  

It seems that everywhere we turn we can’t help but bump into negative news. In our opinion, it’s a viable strategy to take the headlines of every piece of financial news and just do the opposite. Reading everything the financial media throws your way can cause anyone to make emotional investment decisions, much less make their head spin. But as Harry Truman said, “If I want to be great I have to win the victory over myself…self-discipline.”

So we find that if we want to have success in the markets, we must exercise self-discipline at times when it seems an almost impossible task. For us, that discipline encompasses several important tools including adding to a diverse, dynamic asset program as markets arouns the world lower their prices. Our rules are straight forward, there is no room for subjectivity; no room for news headlines to influence the decision making process. Rather the rules are based upon a strategy tailored to our clients.

What is said about the market is not important but rather what is done in the market is.

The business of investing is the business of managing a battle with two primary fronts. There is the risk management front and there is the emotion management front, and it is hard to assign a greater importance to one versus the other, as a neglect of either will lead to disaster. Today I want to share and excerpt from an article by Yee, Ong entitled, “The fear of Missing Out.”

“… the fear that is dominant in the market today is actually the “fear of missing out.” Whether in a restaurant or at work, everywhere you go you will hear people expressing their regrets of not having invested more when the market was at its bottom last year. As a matter of fact, you can start to see that investors who were not fully exposed to the market are flocking out of it right now, as stocks are “on sale”. They feel that they have missed the boat as they witness the capital market world coming to an end.

“This phenomenon is very similar to the one that led to the aforementioned technology and the recent housing bubbles. People who were fearful to invest at the beginning were proven wrong and they found it painful to witness the money that they could’ve earned passed by in front of their eyes. The feeling was especially unpleasant when they sat there being proven wrong for months or even years. After awhile their spouses would yell at them for being too hard headed, agent/brokers would say just hang on, and sometimes even the dog would start barking at them too.”

 

 

Investors Gone Wild

Capital markets are designed to reallocate money from dumb people to smart people. If that weren’t true, smart people wouldn’t play. Smart people don’t play unless they have a probability of winning. For example, smart people don’t tend to play the lottery. (If you have ever wondered why the PowerBall winner is always a nitwit and flat broke again in three years, now you know.) This might be the reason that the rich get richer. I have a high degree of conviction that if one took all of the money in the world and split it equally among all of its inhabitants, ten years later the people who have the money now would be likely to have the money again, simply because they understand what it takes to be successful in capital markets.

Now, when I use the word “smart,” in the context of capital markets, I’m not talking about IQ at all. You don’t have to be a university professor or have an extensive financial background to be smart (and you definitely don’t have to be a “Financial Adviser”.  In fact, it’s even possible those things could work against you. Rather, being smart about the capital markets requires a very specific skill set consisting of three things.

1) Knowledge. Smart means understanding which asset classes are likely to outperform over time. If you plow through all of the investment literature, you will see that it largely boils down to two return factors: relative strength and value. Both are robust and work in numerous formulations. There’s no one formula that is magic. Success is mainly a matter of consistently exposing the portfolio to the asset class with potential for higher returns.

2) Discipline. Smart means understanding that execution is more important than knowledge. It’s not enough to have the knowledge of which return factors will likely work over time. You need to have a systematic method of exposing the portfolio to your chosen asset classes in a disciplined fashion. You cannot waver or let your emotions get in the way–and believe me, your fear will try to run you into the ditch during every correction. Maintain your emotional balance. You must remain resolute up to and including the end-of-the-world scenario. Maybe the world will end and I will be wrong about all of this. Probably not. If you consistently expose your investment capital to a good assets in a disciplined way, you are light years ahead.

3) Patience. Smart means understanding that great patience is required. Most investors, I suppose, would like to get rich quick. That’s unlikely to happen. In a karmic kind of way, the universe actually makes you earn your money by going through trials and tribulations. The E-ticket ride you get in capital markets is never easy, and often not pleasant. Both relative strength and value go in and out of favor as return factors, sometimes slipping into eclipse for years at a time. Great investors are enveloped with a kind of Zen-like calmness. They are neither ecstatic about their profits nor their losses. You can’t take giddy mental ownership of your equity high-water mark or despair at your drawdown during a correction. Stay centered and let compounding work its magic.

As you can see, “smart” relates much more to temperament than IQ. I would go so far as to say the temperament piece is probably the most important. While most investors engage in dumb behaviors like jumping from questionable method to method, adding money when they feel good about their results, pulling money out when they are temporarily panicked, measuring results over a short period of time, hiring and firing managers like a revolving door, and generally running about like a chicken with its head cut off, smart investors pursue reliable return factors with discipline and immense patience. If you take the perspective that the market is designed to take your money when you do something dumb, investors would be well-advised to think about their behavior carefully before every portfolio change.

October 2008: The Dow declined 700 points in the morning and came back 600 points to close down about 100 on the day

The title helps remind us that we’ve seen this before and not that long ago. It seemed like everyone gave up on the world at the same time yesterday. When you look at a chart of the daily trading you see a V shaped cut in the chart that happened around 3PM. It happened to coincide with massive mob rioting in Greece, Brown being overtaken by Cameron with a hung Parliament and oil spewing out in the gulf. Other reports suggest one person pressed a billion shares to sell rather than a million in Proctor and Gamble and the slide started. The Dow Jones jumped back up 500 points in about 5 to 8 minutes which is a massive rally. The big difference is we gained it back in a matter of a few minutes. But just as the indicators guided us through 2008, they will guide us through all types of markets.

Markets like yesterday tend to make people doubt their discipline. Yes, there were bad trades below a $1 for stocks and ETFs so of course common sense tells us to look at time and sales there but relative strength readings are calculated based upon the close of the day when the things had some time to work themselves out. If signals are given they should be taken and we will continue to work through your disciplined, systematic approach in your portfolio management. The levels at which a bullish support line would be violated or a relative strength chart would change was exactly the same on Thursday as what it was on Wednesday. The only difference is that the market made that trade in one day versus a series of days. It is like ripping the band-aid off versus slowly taking it off. In times of upheaval, it’s more important than ever to stick to your discipline versus deviate from it emotionally.

We wish we had a crystal ball, but that’s impossible so we’ll continue to stick with our game plan that has guided us through all types of markets.

“In three words I can sum up everything I’ve learned about life: it goes on.”

- Robert Frost

Thursday’s market was not particularly kind to domestic stocks across all sectors and styles. In a matter of minutes, we witnessed The Dow drop over 1,000 points along with the other major domestic indices. Although the market was able to make up much of this lost ground, the negative action forced the NYSE Bullish Percent (Our primary market indicator) to reverse into a negative bias. The defensive team is effectively on the field. As we have been saying for some time now, even with Domestic Equities favored in our portfolios for all of 2010, the environment has always been one of relatively high risk since our risk barometer (the NYSE BP) had been in overbought territory. Now that the defensive team is back on the field, we must continue to monitor positions, typically not giving stocks the benefit of the doubt on important support violations and it’s never too late to weed out weak relative strength positions. It is no doubt that up until yesterday, we enjoyed a strong run since the market correction in late January. As we go from here, this environment means we have to be even more cautious.

SELL IN MAY AND GO AWAY?

Years ago we learned about the reference tool, Stock Trader’s Almanac, published by Yale Hirsch. One of their notable pieces of information is called “Market Seasonality.” The premise this study is that the market performs far better during the November through April time period than it does from May through October. On its own, that isn’t a particularly profound statement. But when we examine the historical data with which it is substantiated and the magnitude with which this effect has been chronicled over the years, it becomes very significant. As we enter another of those seasonally biased periods, May through October, we want to revisit the subject today.

Consider this: if you were to invest $10,000 in the Dow Jones on May 1st and sell it on October 31st each year since 1950, you have lost money over the last 60 years! Put another way, the entire growth of the Dow stocks since 1950 has effectively come in the “good” six months of the year.

In looking at the seasonally strong period between November 1 and April 30 each year, an identical $10,000 initial investment grew to $538,066 at an average annual rate of 6.87% on a compounding basis. There’s no question that the November to April period has provided substantially better returns. There have been down periods in the seasonally strong stretch, and up periods in the seasonally down period, but what we are referring to is simply a historical bias. Yes, this strategy does have a very strong historical bias, but it is not a “be all, end all” means of risk management.

We now enter the seasonally weak period this time around with domestic and foreign stocks having experienced a massive run over the past year. We will adapt with any change to our fundamental and technical indicators, as they are the objective measures for our portfolio management process. For now we remain invested in equities but cognizant that our positions are entering the seasonally weak stretch.

Again, this study is not the end-all for risk management, but the study is interesting and does expose a bias within the market of which many investors are not aware. For the time being, we continue to see positive signs across market indices from the overall trends of domestic and international equities. While entering the seasonally weak period in the market in and of itself is not cause to take action, it does mean that we will keep a close eye on the market right now, and that our game plan is in place to adapt to any potential changes.

Having a two year old son can be as joyous as it is trying sometimes. I often try to remember that when you have an only child he is often under a microscope with respect to his behavior versus when you have multiple kids. I come to realize I need to loosen up a little bit, kids will be kids, pick your battles.

As I was examining the recent changes in my indicators this week, it brought me to remembering this advice. I believe it impossible to time the market, but it is possible to manage risk. We cannot be in the best performing investment every year. Rather we work to capture gains when certain asset classes (whether they be domestic equities, international equities, commodities, currencies, or fixed income) are rising; and when markets are falling, find ways to protect capital and waiting for future opportunities.

Tuesday brought one of the biggest declines of 2010 and that always gets investors nervous. Was it a one-day event that ended as quickly as it began, or is the start of something more dramatic and prolonged? Thus far Tuesday’s session doesn’t appear to be anything out of the ordinary. We don’t like to see huge declines in the market anymore than the next manager, but in the grand scheme of things Tuesday’s market was not in itself “huge”. In fact, it actually wasn’t the biggest decline this year.

Largest Declines of 2010 for the Dow Industrials

• February 4th, 2010: -268.37 points
• January 22nd, 2010: -216.90 points
• January 21st, 2010: -213.27 points
• April 27th, 2010: -213.04 points

A notable observation is that momentum has generally swung in the negative direction over the past week. Momentum for the Dow Diamonds, as an example, had been positive since the first week of March. But it has now flipped negative as we end the month of April. Right now this is not a game-changing event, but paired with the overbought nature of the equities market, it does add further reason for us to be patient with new positions and be ready for any changes in our indicators that would with tell us to start running plays from our defensive playbook.

Global Market Performance

As you know we are believers in global investing. The United States has never been the top performing market in any one year. Here are a few noteworthy performance observations for 2010:

All International ETFs specific to the Pacific Rim region moved to new 52-week highs this month – with the notable exception of China. Simply put, China has been unable to participate in the gains that have been throughout the Asia region. The Jakarta Stock Price Index (Indonesia), for instance, is up 25.6% and India’s BSE 500 is up 14.4% over the last six months. Over the same timeframe the Shanghai index has only managed to tread water at +0.195%.

BGB