Oil Down, Good

There has been a big fuss made over lower oil prices and they are cratering:

So the logic goes: lower oil prices = less global demand for oil = weaker economy.  Makes sense.  Except in the US lower oil prices = more cash available for other consumer purchases = stronger economy.  And in reality it’s spikes in oil prices, not dives, that correspond with recessions:

Maybe the market is signaling something different this time, but in the past lower prices have been good for the economy and stocks.

*Please see the important disclosures that apply to this commentary HERE.  The above charts are for illustrative purposes only and do not attempt to predict actual results of any particular investment.

Following the Lead on Interest Rates Isn’t a Strategy

Building a portfolio based solely on market consensus or projections isn't a strategy – it’s hope based investing.

Interest rates going up has been the consensus view since 2009.  Eventually this view will be right, so far it really hasn’t.  When exactly they go up I am unsure of, though I tend to think later than most. 

One thing I will not due is blindly follow market projections or consensus calls, which appear to be nothing more than throwing darts.  While the recent Fed statement contains “considerable time” before an interest rate increase, futures markets are assuming this will happen mid 2015:

Note:  This chart isn’t easy to read.  The blue line shows the actual Fed Funds rate, which is effectively 0 and has been since mid-2009.  The orange line shows what the futures market is predicting the rate will be in the future at the start of the line (e.g. when rates reached 0 in mid-2009 futures markets expected rates to rise back up quickly and be at 2.50% or so by mid-2010).  Lastly, the green line shows where we currently are that rates are projected to rise in mid-2015 and be at almost 3% by 2017.  Also, this chart was printed before the latest Fed Statement and thus futures markets may have adjusted.

What we can observe in the above charts is that market participants always expected the next rate rise to come and it never did.  Now markets did get better, projecting the rate rise out further and further, but none the less were still off. 

Will it be mid-2015?  Not sure, but even some widely used Fed models project the rate increase will be further out:

What about consensus analyst?  Not much better:

Source:  DoubleLine Funds

As you can see the black line where analysts expect the 10 year to be at year-end.  It has consistently moved down all year, along with interest rates.  Again, analysts have missed the calls on interest and this has been a reoccurring theme since 2009.

I am not advocating totally ignoring projections (though not a terrible idea I must admit and certainly better than the other extreme – following them religiously), nor am I advocating making your own market calls. 

But building a portfolio based solely on market consensus or projections isn’t a strategy – it’s hope based investing.  Instead, 1) make probabilistic assessments 2) have a plan if/when those move against you.

*Please see the important disclosures that apply to this commentary HERE.  The above charts are for illustrative purposes only and do not attempt to predict actual results of any particular investment.

Stocks Should be Okay as Long as Economy is Expanding

• According to the chart below, since 1954, economic expansions tend to be a good time to be invested in stocks (SPX = S&P 500*):

• Some observations:
• As the numbers show, we are about 62 months through this one
• It’s right around the average and median since 1954
• Further, there were 4 expansions longer than this once
• The market return has been greater than average, though the market did have a lower bottom than any market prior
• Valuation level was also at a relative low:
  
• And regardless, there have been 2 expansions where the returns were higher
• Anyway, all this says to me that we aren’t in unprecedented territory in terms of length or stock growth in this expansion…
• And while we might be long in the tooth, nothing in the data indicates we are at extreme levels
• But what if the expansion is ending…
• Maybe the expansion ended this month and we didn’t realize it for 6 months (recessions are usually decided after the fact).  Highly unlikely with GDP coming in at 4.2%, but even so the first 6 months of a recession haven’t been destructive for stock market returns, assuming you hold throughout:
  
• Ok, we likely aren’t in a recession now, but what if we start a recession in 6 months?  After all, the common mantra is that markets lead the economy.  Again, while the returns are likely negative:
  
• Altogether Now:
• Expansions yield solid returns for stocks
• It’s likely we are still in an expansion (note: ISM has been in recession once with ISM at 59 or higher):
  
• Even if we are going into a recession, the months leading up to a recession haven’t had a HUGE drawdown (> 25%), despite a likelihood they will be negative
• Thus, as it’s highly probable the economy is expanding there are potential equity returns that outweigh the risk of a drawdown…
• And as a result waiting to pair back your equity exposure until you are certain the economic fundamentals have deteriorated is likely prudent

*Please see the important disclosures that apply to this commentary HERE.  The above charts are for illustrative purposes only and do not attempt to predict actual results of any particular investment.

Euro Economy = Bad; Euro Stocks = Good (maybe)

1. Europe’s economy is going back in the trash as GDP is flat with even all mighty Germany turning negative (see red bars indicating economic growth from the prior period):
   
2. This has been a persistent theme, since 2009 other developed economies – US, Japan, Britain – have grown faster while Europe has stagnated:
   
3. European stocks have reflected this economic weakness as US stocks (SPX on chart below) have returned much more than European stocks (FEZ on chart below) since the end of 2008 (note: the S&P 500* bottom early March 2009, though chart is intra-month making bottom appear to be February 2009):
   
4. However, this underperformance of European stocks has possibly presented an opportunity though as European stocks are now cheaper (note: cheap stocks in general should have more room to grow than more expensive stocks):
   
5. Further, the ECB has yet to institute quantitative easing (QE), but the rumors are swirling.  In the US, QE worked out nicely for US equity markets as each listed program in the chart below resulted in a subsequent move higher in the stock market:
   
6. Thus, if/when the ECB version of QE it could have a positive effect on European equity prices as it did on the US.  Plus the stocks are relatively cheap so there could be some more room to grow.

Caveat: the trend in the European stocks is weak so for the time being caution should be used.

Note:  On 09/04/14 the ECB cut interest rates and may or may not enact quantitative easing later in the day or in coming months.  European stock markets were higher.  This post was written before today’s news.

*Please see the important disclosures that apply to this commentary HERE.  The above charts are for illustrative purposes only and do not attempt to predict actual results of any particular investment.

Why the QE Tapper Matters.

Stocks have gone up with the Fed’s balance sheet, so what happens when the latter is no longer the case?

There are a lot of things that don’t really matter to the markets much of the time.  A short list:

• Geopolitical – the world is always fighting somewhere
• Congress – do they ever get along?
• Data Points – trends > one piece of data
• Analyst Targets – no idea how any of these can be accurate

Not that any of those can’t ultimately change the markets, but I can’t think of a logical reason to sell because country X on the other side of the world might invade country Y on the side of the world.  How does that matter to the US again?

Anyway, I digress.  One thing I do think matters is the quantitative easing tapering (QE).  QE is when the Fed buys longer-term Treasuries to force down rates in attempt to increase lending and subsequently boost the economy.  Its actual impact on the economy can be argued, but from my point of view it has had a large impact on the stock market:

Shown another way:

So what is obvious from the charts is that the larger the Fed’s balance sheet, the higher the S&P 500*.  Further, when the balance sheet didn’t move we had almost a 20% move down in the stock market (red circle).

Anyway, the Fed is “tapering” their purchases.  What was once $80b a month is now around $25b.  They haven’t stopped buying and certainly aren’t selling, but they are cutting back.    So while day to day noise tend to be the headlines, the real focus should be on what happens when the Fed’s balance sheet stops getting bigger?

Please see the important disclosures that apply to this commentary HERE.  See important definition on the S&P 500 at the same link.  The above charts are for illustrative purposes only and does not attempt to predict actual results of any particular investment.  In regard to both charts, Source: S&P 500 - FRED and FED Treasury Holdings - FRED; calculations by CAL and idea via Market Anthropology

Avoid an Investment If…

Use research to come to an investment decision, avoid being a sheep

Maybe avoid is the wrong word.  More like don’t blindly follow.  I am talking about information friends, clients, family, etc. use as a justification why they (and you) should invest in ABC.  The following should give you pause, as they are fairly weak justifications:

1. Advice from a political pundits or their sponsors
2. Chain emails
3. A guy who got a past market call right
4. Anything said from a permabull or permabear
5. Golf course investing tips
6. Any inside information
7. A guy who has a TV show
8. Anything from an investment company
9. Returns that are much higher than the market
10. Anything you can’t really understand

And why:

1. They are pushing politics or their revenue stream, not investments
2. Usually crazy rumors with little basis in reality
3. Yes, could give the guy credibility OR every blind squirrel finds a nut
4. If they are always bullish or always bearish they have a predisposed view of the market
5. Typically people only talk about their winners
6. Aside from being illegal probably isn’t inside anyway
7. He or she is gunning for ratings, not necessarily investment advice
8. They are pushing a product (caveat: they could have some pretty good research)
9. All good things come to an end or it’s a total fabrication
10. More confusing = more costly AND/OR less idea of how it will perform

Of course, this list is not all encompassing.  Just what popped into my head.

Justified is the key word.  Any of the above may ultimately have the right call on the market or an investment; however, I would bet using any of the above as the ONLY reason to invest in something will often end in disappointment. 

Point being, do your own research to formulate your own thesis or find some research with an actual thesis before making a decision either way and if you see fit use one of the items from the list above to compliment that thesis. 

Please see the important disclosures that apply to this commentary HERE. 

Reducing the Risks from Your Brain

“Knowledge alone isn’t enough. Even though we know it’s a bad idea to buy high and sell low, spend more than we earn, or invest in only one stock, we still repeat these mistakes… So ignoring what we’ve learned in the past makes it difficult to benefit from that knowledge. And pretending that there’s no consequence in the future for the decisions we make today creates a similar conflict.”

 The above sums up what I found to be a quick, insightful article in the New York Times.  It touches on the most overlooked issue in personal finance – the psychological barriers to making sound financial decisions. 

We take great pride in trying to educate our clients, often using the phrase “a great client is an educated one.”   However, as the article indicates information alone may have limitations when rubber meets the road as the client may convince him or herself otherwise using the “this time is different” or “we can make up for it down the road” or anything really as a reason.

The article mentions “by recognizing the impact our [psychological issues] may have, we stand a greater chance of turning that knowledge into good behavior”, but does little mention ideas to help with the recognition.  We understand that human nature won’t change and thus those issues will never go away.  Thus, we have taken steps to minimize their impact and proactively prevent them:

• Build a financial roadmap so clients have a clear understanding of how a financial decision will affect their long-term goals and objectives and balance sheet/cash flow trends.
• On top of client education, we take time to answer all client questions thoroughly so they will understand our plan to alleviate their concern.
• Transparency in our process helps understand the how and why of our recommendations.
• Reducing risk as market movements indicate a higher probability or large loss in the future in order to keep them from selling at the bottom.
• Meeting clients in the middle.  For example, putting a % of what they were going to invest in a private investment instead of the original amount

Of course, these methods are not perfect and we constantly evolve to find new and better ways to mitigate the psychological risks.  Still, the above are good first steps to recognizing the deficiencies we have and taking steps to avoid the pitfalls the deficiencies can bring.  

Please see the important disclosures that apply to this commentary HERE. 

Time for Active to Shine?

Picking active managers isn't easy, but for those who are disciplined and know what they are looking for this could be the right time to go active.

For at least a decade now passive management (managers who attempt to mimic an index) has been all the rage.  Originally passive management advocates were only on posters in Tiger Beat, but now they are on the cover of Vanity Fair.  More and more we get research, white papers, even client calls extolling the virtue of passive management over their active counterparts (managers who attempt to beat an index).  The trend continues to move more and more toward passive managers.  Will this ever change?

No, at least not forever, and I am a big advocate of passive management.  The reason was highlighted to me in the article.*  Thesis: the trend will continue to move as millennials, who are skeptical of active management, migrate to passive managers and the older active managers, who make up the bulk of active management, retire leaving new managers with little track record.

But the reason the trend will eventually reverse is the same reason why the money ultimately started flowing that way – returns:

1. Active management became popular in the 80s as ways to get diversified* market exposure and good rates of return
2. As it gained in more popularity, more managers entered the field = lower % of managers beating their respective index as quality erodes. 
3. Many of these managers raised their fees given the increased demand, lessening their chance to beat the benchmark
4. So here comes passive managers, cheaper and better performing than active managers
5. Repeat steps 2 and 3 AND lower quality active managers leave the field as dollars move to passive AND if everyone is buying an index stocks will naturally become over and undervalued, creating a nice situation for active managers AND creates a self-reinforcing problem - during a market selloff who is buying if everyone is passive?  This is where we are at.
6. The small pool of high quality active managers who were probably in cash before the sell-off and may now be well positioned to outperform over the full market cycle
7. Start over again

The debate of for academics, but why does this trend matter to retail investors?  Opportunity.  With everyone moving towards passive management, quality active managers should be better situated to beat an index over a full market cycle.  Picking active managers isn’t easy, but for those who are disciplined and know what they are looking for this could be the right time to go active.

Please see the important disclosures that apply to this commentary HERE.  See important definition on diversification at the same link.

The LeBron Trade

Huge upside and a downside that doesn’t cripple you may be an investment worth making

NBA Free Agency is the ultimate reality show.  Rumors, innuendo, last minute game changes, etc.  Quite fascinating really.  The winner gets LeBron James, the loser, a set of steak knives …

Well not really a set of steak knives for the Cavs.  They have a young, talented roster they can continue building with or without LeBron, though would certainly be better with him.  The Heat on the other hand would pretty much be destitute.

Regardless, it’s really a binary outcome – you either get him or you don’t.  The former obviously puts you in a substantially better situation.

But diverting resources to get LeBron hampers your ability to sign other free agents, who would improve your team.  The opportunity cost of chasing LeBron is enormous where you can’t really do anything until he signs.  For example, the Cavs lost out on Gordon Hayward as they have dedicated themselves to trying to get LeBron back on the team.

Thus, the argument could be made are you better off going after lower level free agents who you have a better chance of signing and will still improve your team?    To illustrate, let’s say the Cavs have a 10% chance of signing LeBron and 75% chance of signing free agent ABC.  Free agent ABC makes the Cavs a playoff team, maybe even a high seed in the East.  LeBron however makes you an instant title contender and a possible free agent destination, not to mention makes you increasingly more relevant.

Point being the upside is so great with LeBron that the opportunity cost of losing other free agents is totally irrelevant and thus the argument of using your resources to target more likely lower free agents moot.   The Cavs need to and have make this LeBron trade.

I do need to attempt to tie this back to investing.  And I think I can.  If you can find an investment, whether in the market or private or a startup, with huge upside and a downside that doesn’t cripple you it may be an investment worth making.  This may be true even if the likelihood of success is low and the opportunity cost is marginally high.  Good look finding your LeBron trade…

Please see the important disclosures that apply to this commentary HERE.

Use LeBron to Assist Your Portfolio Plan

LeBron will probably stay with the Heat; how I came to that conclusion can apply to portfolio management.

In all likelihood the best player in the NBA isn’t leaving the Heat.  As someone who likes the Cavs, I am a tad bummed; however, the Cavs and Heat should both be very entertaining.

On the surface this has little to do with your portfolio, but let’s use this as an example:

1. What I did in the above picture is list reasons why he would stay on the Heat and why he would leave. 
2. Everything in the above picture I deem as signals, items that indicate the direction of the ultimate outcome. 
3. Items above the red are why I think he stays, and below why he might leave (though those are more mixed).
4. Anything else I hear about LeBron I deem as noise, distortions that cause a loss of focus on what is the likely outcome.  For example: his kids are enrolled at school ABC, his wife wants to move back to Akron, he wants to play with Carmelo, etc.
5. Thus, given the signals as I read them the evidence is overwhelming he stays.

In short, I ignore the noise and read the signals to formulate that thesis.  But in practice it isn’t that simple: maybe some of the noise were actually a signals OR vice versa OR one of the mixed signals comes to fruition OR I missed something entirely OR maybe I am looking for confirmation bias.  Despite the sound process in theory, it certainly isn’t infallible given the highly subjective nature.

When it comes to portfolio management, I apply the same decision making process – look for signals (e.g. + likelihood of solid economic growth, + loose Fed, - uncertainty of QE unwind, +/- above average valuation) and ignore the noise (e.g. whatever is going on in Ukraine, endless Fed comments) to formulate a thesis (e.g. the background for stocks should be positive though with some headwinds).

Much like my LeBron thesis, the above can ultimately prove to be untrue as my assessment of the signals is subjective.  However, unlike like the LeBron thesis there are more objective signals from the market I can incorporate into portfolio management in the event my thesis fails.  It’s these objective signals that help hedge against the “OR” mistakes listed above, a luxury that wasn’t available when I formulated my assessment on LeBron.

So while in portfolio management it’s imperative to ignore noise and pay great attention to signals when going through the process, it’s equally imperative to have measures in place to guard against making the wrong decision.  The latter may not help figuring out where LeBron will land, but it could help minimize your drawdowns when the market corrects.

Please see the important disclosures that apply to this commentary HERE.

Cash is Okay, if You Hold it the Right Way

Don’t be in cash for the wrong reason, be cognizant of all the risks you can, but avoid making investment decisions until they start to materialize…

Investors are holding cash.  Not only that…

• They are holding more than they were a few years ago
• This is a global phenomenon with the US being somewhere in the middle at roughly 36% of assets in cash (40% Global average)
• This is true, regardless of age and wealth
• Paradoxically, younger investors who have a longer time horizon are increasing their cash holdings as much as older investors

(Source: NYT)

Why the apprehension?  Fear makes the most sense.  The amount of things to worried about seems to be endless and evolving, off the top of my head: high frequency trading, Iraq, Iran, Afghanistan, let’s just call it the whole Middle East, Europe is on the brink (as always), Russia is being mean, China’s real estate bubble never goes away, the Fed will tighten and the market will drop, the Fed will stay easy and inflation will be a huge issue, stock valuations are high, we just had a negative Q1 GDP print, Game of Thrones is gone for a year, the Cavs will blow another top pick, etc.

But despite all that, the S&P 500 is up almost 40% since the start of 2013 and positive this year.  Just my guess, but those who have been invested in cash have maybe earned 1%?  I would guess cash people at the start would list those risks as why they are in cash.  Now they would mention those reasons and a rising equity market as to why they should stay there.

Admittedly this is easy in hindsight.  Further, there are legit strategic investment reasons to hold cash, many investors psychologically can’t handle the volatility of the markets (and that’s okay), and/or who is to say that some of those fears won’t materialize?  What is of concern is how those decisions are made, if reading headlines, watching the News, looking daily at your portfolio values, or listening to a Gold infomercial has you moving to cash there is a high probability this move(s) was made for the wrong reason(s).

Naturally, this begs the question of what to do.  I will tackle this working backwards, here is a list of don’ts:

1. Don’t take on more volatility than you can handle – too much risk means you will likely move to cash as soon as the market moves against you, but most of the time this will be noise
2. Don’t be overly reactive – going to cash because XYZ just happened, again most of the time this will be noise
3. Don’t be overly proactive – dismissing everything as noise, when sometimes there are signals that indicate a market shift
4. Don’t Not Have a Plan (sorry for the 2x negative) – pretty much encompasses the prior three

My approach is simple – be cognizant of all the risks you can, but avoid making investment decisions until they start to materialize and always stay hedged against the unknown and those risks which occur quickly. 

Side Note:  We are working on a way to shrink the disclosures.  Hopefully in the future they won’t be as overwhelming. 

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.  The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss.

S&P 500 Index is an index of 500 of the largest exchange-traded stocks in the US from a broad range of industries whose collective performance mirrors the overall stock market. 

International investing involves special risks, including, but not limited to, currency fluctuations, economic instability, and political uncertainties, not typically present with domestic investments.

Gross Domestic Product (GDP) is a measure of output from U.S factories and related consumption in the United States.  It does not include products made by U.S. companies in foreign markets.

Inflation is the rise in the prices of goods and services, as happens when spending increases relative to the supply of goods on the market.  Moderate inflation is a common result of economic growth.  Hyperinflation, with prices rising at 100% a year or more, causes people to lose confidence in the currency and put their assets in hard assets like real estate or gold, which usually retain their value in inflationary times.

Advisory services offered through Capital Advisors, Ltd, Capital Analysts, Inc. or Lincoln Investment, Registered Investment Advisors. Securities offered through Lincoln Investment, Broker Dealer, Member FINRA/SIPC. www.lincolninvestment.com

Capital Advisors, Ltd and the above firms are independent, non-affiliated entities.

Selling Your Business: The Right Price at the Right Time

First, sorry for posting this twice; however, I was informed the first link didn't work in the last post.  Thus, I have updated the link so those who receive by email have a working link to part 1...

Neil and I wrote this two part blog series for Crain's.  They are different from the typical investment themes on here; however, they are still worth checking out!  Please go to Crain's to read:

1. http://www.crainscleveland.com/article/20140528/BLOGS05/140529902/selling-your-business-the-right-price-at-the-right-time-part-1-of-2
2. http://www.crainscleveland.com/article/20140604/BLOGS05/140529901/selling-your-business-the-right-price-at-the-right-time-part-2-of-2

Selling Your Business: The Right Price at the Right Time

Neil and I wrote this two part blog series for Crain's.  They are different from the typical investment themes on here; however, they are still worth checking out!  Please go to Crain's to read:

1. http://www.crainscleveland.com/article/20140528/BLOGS05/140529902/selling-your-business-the-right-price-at-the-right-time-part-1-of-2
2. http://www.crainscleveland.com/article/20140604/BLOGS05/140529901/selling-your-business-the-right-price-at-the-right-time-part-2-of-2

Bonds Holding Strong?

Bonds are moving against what logic would dictate this year and investor portfolios should be prepared for a multitude of outcomes.

As of last Friday bonds, as measured by ETF AGG, are up 2.88%. (per Yahoo! Finance)  This is a slap in the face to the consensus, which expected yields up and bond prices down.

Here are some facts/consensus:

1. Stocks are also up a little over 2%.  (per Yahoo! Finance)
2. While economic growth stunk it up in Q1, consensus is still positive for the year.
3. The Fed is tapering, which means they are buying less long dated bonds.

The above, at least in theory, should equate to higher bonds yields and lower prices because:

1. Stocks and bonds are thought to move in opposite directions as the former is considered risk-on and the latter is risk off.
2. Positive economic growth should increase risk appetite (see above) and inflation, which hurts bonds.
3. Less buying = less demand with same supply = lower prices = higher yields.

So it all makes sense for higher yields, but maybe this is the reality:

1. Stocks and bonds aren’t really negatively correlated.  Sometimes they move together, other times they don’t, sometimes they move in opposite directions.  It really depends on the period.
2. Maybe bonds are telling us the economy isn’t going to pick up?  Inflation is still in a downtrend too. 
3. Some other buyers are picking up the slack.  Think about it, a 10 year at 2.60% is a lot more appealing than at 1.40%.
4. BONUS!  The bond market is wrong.

I am not sure which one it is, but one thing is certain - bonds are moving against what logic would dictate this year and investor portfolios should be prepared for a multitude of outcomes.

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.  The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss.

Inflation is the rise in the prices of goods and services, as happens when spending increases relative to the supply of goods on the market.  Moderate inflation is a common result of economic growth.  Hyperinflation, with prices rising at 100% a year or more, causes people to lose confidence in the currency and put their assets in hard assets like real estate or gold, which usually retain their value in inflationary times

Advisory services offered through Capital Analysts, Inc. or Lincoln Investment, Registered Investment Advisors. Securities offered through Lincoln Investment, Broker Dealer, Member FINRA/SIPC. www.lincolninvestment.com

Capital Advisors, Ltd. and the above firms are independent, non-affiliated entities

A Plan When Good Things (Rising Equity Market) Come to End

Tailoring downside portfolio risk to an investor’s risk tolerance, goals/objectives, and future cash flows can help reduce the probability the investor will experience a catastrophic loss. 

I last wrote (way too long ago) that hope isn’t an investment strategy when the markets start moving against you, but I failed to give a solution.  A client then wisely asked me to elaborate on the plan we have in place for him, so I walked him through it.

Below is an abridged version of my response.  It outlines his, as well as other clients, portfolio risk management strategy.  Nothing is full-proof, but what this strategy does attempt to do is prevent losses from becoming catastrophic.  This is where panic selling often takes place, compounding the losses. 

By focusing on the client, their risk tolerance, goals/objectives, and future cash flow we can put together a plan that helps reduce the probability of a loss that would have drastic implications for the client moving forward: 

1. Diversification.  By utilizing bonds we can help reduce the downside if equity markets fall.  This smooths returns over the long-run and helps balance the account when stock returns get ugly.  Still, even with diversification returns can be much lower than would be expected given historic returns and volatility…
2. Quality.  We keep the bulk of our assets in Large Cap equities and also allocate more to blue chips in that space.  This minimizes exposure to some of the riskier equity asset classes out there.  So while we may have a muted upside, we believe the downside should also be muted.  Still, the baby can get thrown out with the bath water when the market tanks, so we aren’t done…
3. De-Risk.  We are still bullish on equities now, but what if that changes or we are wrong?  We look for market signals to tell us when we should de-risk the portfolio (e.g. sell equities).  These signals tell us if the market is at a greater risk of a large loss and happen as the market moves down, so we aren’t trying to pick the top, but rather avoid much of the bottom(ing).  These signals have been very good in the past, we have custom models that illustrate this, but there is a chance they could not work…
4. Custom Waterline.  We put together a bespoke cash flow model for our clients, which maps their inflows and outflows moving forward.  From this we can develop a “waterline” – the minimum portfolio value a client can have and may still reach their long-term financial goals.  What this means is that if all the above risk metrics fail we can move to cash on the equity side when this value is met.  Using the waterline allows us to manage specifically to THE CLIENT’S needs and helps increase the probability we keep them financially stable over the long-run.

Ultimately these strategies are in place to protect the downside for the client, and subsequently help give them some clarity.  If we can do that by minimizing the downside risks, the returns should take care of themselves.

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.  The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss.

While there is no assurance that a diversified portfolio will produce better returns than an undiversified portfolio, and it does not assure against market loss, a diversified portfolio can reduce a portfolio’s volatility and potential loss.

Large cap stocks typically have at least $5 billion in outstanding market value. 

Good Things Come to End, Have a Plan

Hoping and wishing your portfolio will hold up when the market turns negative, and turn it will, isn’t a strategy.  Being prepared is the only prudent way to invest.

The last few commentaries have had a bullish bent, and rightfully so, but it’s important for me to scratch my “always concerned about the markets” itch.

Here is a snippet from legendary investor Seth Klarman’s letter.  The whole thing is great, but below are my favorite parts:

• On the current state of the economy/markets: monetary policy is distorting markets, Fed can change how things look, but not what they are, Europe isn’t any better, not many bears left, unsustainable tech business models. 
• “Someday, financial markets will again decline.”
• “Someday, professional investors will come to work and fear will have come to the markets and that fear will spread like wildfire. The news flow will be bad, and the markets will be tumbling.”
• “Can we say when it will end? No. Can we say that it will end? Yes. And when it ends and the trend reverses, here is what we can say for sure. Few will be ready. Few will be prepared.”

Currently, in light of all this, Klarman returned $4b to investors and is 40% in cash.  He can’t find much to buy as everything has been bid up.  Does that mean the market is destined to collapse at any moment?  No, and Klarman noted that in his letter. 

But what he does say is that markets will decline again.  I wouldn’t bet against that assumption.  Further, he noted that most will be unprepared for such a drop and thus will be very vulnerable when this happens.

Don’t wish, don’t hope.  Have a plan to protect your capital.  That is the foundation of how I approach investing.

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.  The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss.