Market Commentary for the week of April 14, 2009

All about balance.
Previously unchallenged tenets of investing have been severely challenged during this bear market, and causing cognitive disruptions along the way. How many of us believe, and have always instinctively believed, that “staying the course over the long term” is the most successful way to ride out the tough times and turbulence of the financial markets?

Well, if you subscribed to that axiom from the beginnings of this last bull market (2002) through to the end (2009) you would have zero net return in your equity portfolio and significant losses (due to pricing inefficiencies) in your bond portfolio, today.

Additionally each bull/bear cycle in the market’s history has seen capitulations of almost 50% from that cycle’s high to its termination.

We are taught to stay the course, but in reality we must be more nimble than that.

The premise of my modeling (Arlington Econometrics) is that asset allocation and fluidity of portfolio balancing is the essence of successful investing by quantifying the relative strength of certain macro trends, sectors, and financial instruments within those sectors. Therefore, I can more efficiently generate returns by underweighting lagging momentum and overweighting current momentum.

These assumptions are corroborated by a 30 year track record (and back-testing) in which we outperform traditional equity-only benchmarks by 2 to 1.

The new market uncertainty challenges client’s patience and belief in the old maxims, and makes them cautious about investing. How can they draw certitude from confusion about macro trends, politics, and monetary policy?

I think we need to throw away traditional definitions and boxes that make us identify with certain trends. The tech investors of the 1990’s made money, then lost it, by identifying with one sector. Value investors see potential only in depressed stocks, of which there are now many.

Whether by ideology, sector or region it is difficult to pigeon-hole one’s style and be successful under every market circumstance.

At its core, methodology.
The hallmark of successful investing, in fact, is to modulate risk/return allocations, not just “at the edges” of a portfolio, but from within and at its core. This is not “trading”, but, rather, “balancing” a series of short-term decisions into a cohesive long-term pattern.

My work is currently indicating a strong probability of the current short uptrends expiring during this month, gathering at the bottom, and setting the stage for a broader, stronger push in the next upside bounce.

Before we can effectively deliver portfolio results for clients, we must advise them to recalibrate their expectations from unrealistic double-digit excesses of previous decades back to nominal realities of what unleveraged capital can really accomplish.

There is no question that this market’s decline has been punishing and unprecedented. We are wringing out every excess, every spike, with extreme prejudice. There may be more to come. Adjusting to less leverage, less borrowing, is a psychological as well as fiscal challenge. The disproportionate influence of the financial sector, housing, and leveraged excess went well beyond the market’s ability to process those data.

Additionally, non-financial exogenous factors similarly exert pressure upon the free-flow of capital and/or an orderly flow of commercial services.
The offshoot of these crises is how well we will monitor data and process decision-making in the future. We all must be aware of how our biases influence our interpretations, and learn to position those factors into a more objective methodology.