Behind closed doors U.S. politicians on both sides of the aisle acknowledge that something needs to be done about the future cost of entitlement programs and our growing national debt. The secular bear market view holds that the U.S. will not be able to fix these issues politically and the problem will eventually be resolved by a riot in the financial markets. In this view, stocks will not be able to mount a sustained multi-year rally until the structural risks posed by the U.S. debt mountain are resolved. But as we head into the election season, it is also worth considering the secular bull market view. If the U.S. election helps lay the groundwork for an acceptable long-term solution to our debt problems, then there is plenty of room for stock market multiples to be supported going forward.
Two articles by the Wall Street Journal’s Tom Lauricella, one of my favorite writers, came across my desk last week. With titles like “’Go Anywhere’ Goes Awry” and “Macro Funds Show Micro Returns,” the message was clear: Go Anywhere mutual funds and global macro hedge funds are having a tough time earning positive returns in the current market environment.
Back in the second quarter our theme was “consolidation and continuation”, meaning we were looking for a market correction that would lead into a continuation of the bull market (See April 20, 2012 “Looking Ahead to Second Quarter”). Well, the correction we were looking for clearly unfolded, taking the S&P 500 down about 10% between April and June. More recently, the market has rallied 11% off the June bottom, and it is now beginning to feel like the continuation phase that we were expecting is taking hold. After an eleven percent run from June, we are forced to reassess expectations for the market going forward so we can position our client portfolios accordingly.
Recently I was interviewed by Money Magazine on the topic of Exchange Traded Funds (ETFs). I pointed out that ETFs are an excellent investment tool to implement a sector rotation strategy, and that sector rotation was completely different from the Morningstar Style-Box approach to equity selection. Morningstar is perhaps the best-known research firm specializing in independent mutual fund analysis and its star-rating system is widely used in the investment industry. In 1992 Morningstar introduced a system for categorizing mutual funds by investment style. The Morningstar Style Box (on the right) divides the equity mutual fund universe by two major characteristics: market capitalization (or the market value of the companies in a fund) and the valuation of the stocks in a fund based on the P/E and P/B ratios. So a mutual fund that owns large cap stocks with high P/E and P/B ratios is likely to be found in the large growth, or upper right hand quadrant of the box.
We continue to position portfolios at neutral levels of risk, believing that the substantial downside risks (Europe, the looming fiscal cliff, an economic slowdown, etc.) are balanced by the growing possibility that global central banks may soon inject more stimulus that could propel risk markets higher again — similar to what’s happened the past two years (see our June Market Review for more details on our outlook).
Florida is one of the most desirable retirement destinations in the world, and with good reason. It boasts a wonderful climate, miles of beautiful beaches, and many tourist attractions. But probably the greatest motivation for obtaining Florida residency is the range of tax advantages that it brings.
As recently as this week Spanish bond yields had been roiling the markets as they crossed the 7% threshold that is considered the point of no return. With system risk rising anew, the onus was on policy makers to get moving in another attempt to bring down spreads and calm global markets. In the last few days, policy makers have not disappointed on the rhetoric front.
I just returned from a trip to Canada that took me from Niagara Falls to Toronto to Montreal to Old Quebec, and then back to the U.S. Our final stop before getting on the plane home was the Norman Rockwell museum in Brockton, Massachusetts. The museum owns hundreds of Rockwell’s original paintings, many of which are iconic images that once graced the cover of the Saturday Evening Post. In the mid-1980s, the artist’s last studio was moved to the museum grounds, and curators have faithfully recreated it as it was when he was at his busiest.
A few weeks ago, I introduced you to the concept of pro-forma portfolios, and explained how we use them to estimate our current portfolios’ position in terms of volatility and beta. There is an Italian saying that could be translated as “to trust is good, not to trust is better.” While the pro-forma portfolios give us the best possible ex-ante estimates of the amount of risk in the portfolios, these are by definition estimates and not reality, and we can only trust them so much. For this reason we have developed two very short-term measures of volatility and beta based on the actual daily portfolio returns, which we routinely compare to the pro-forma estimates to make sure the portfolios are in fact behaving as we expected. The first measure is called one-month time-weighted trailing volatility and starts with the calculation of the equal-weighted average of the portfolio’s daily volatility over trailing 5 days (1 week), 10 days (2 weeks) and 20 days (4 weeks). This number is then divided by the same average volatility calculated for the portfolio’s benchmark. The ratio gives us a measure of how volatile the portfolio is being relative to its benchmark:
A journalist once asked me what advice I’d give a 60-year old, about to retire. To be honest, I might as well have been asked to list the causes of the Civil War. From the perspective of a trained financial planner and the Chief Investment Officer of a private wealth management firm, the question is, well… difficult. The journalist was writing for the Wall Street Journal and looking for sound investment advice for folks who have been buy and hold investors for their entire investing lives, and now faced the dawning realization that buying and holding is actually a high risk strategy in expensive markets.